Are you dealing in cryptocurrency (e.g., Bitcoin), also referred to as “digital currency” or “virtual currency?” If you are, you should be considering your options when it comes to tax compliance because you may be in the crosshairs of an ongoing IRS compliance initiative.
John Doe Summonses
In 2016, the IRS issued a “John Doe Summons” to Coinbase Inc., one of the major virtual currency exchanges, obtaining the identities of U.S. taxpayers who conducted transactions in virtual currency. A John Doe Summons is a summons in which the IRS does not yet know the identity of the person(s) related to who they are seeking information.
IRS Virtual Currency Compliance Campaign
In 2018, the IRS announced a Virtual Currency Compliance campaign and said it would be addressing noncompliance through audits and criminal investigations. Just last month, it announced that it is now issuing warning letters to 10,000 cryptocurrency holders who potentially failed to report taxable income related to the digital currency.
The IRS has issued three types of letters: Letter 6174, Letter 6174-A, and Letter 6173. The first two are essentially warning letters that do not require a response. The last one, the Letter 6173, notifies the taxpayers that the IRS has received information indicating they may not have complied with reporting requirements related to virtual currency and requires them to respond within 30 days.
Similarities to Offshore Crackdown
This new compliance initiative is reminiscent of the IRS crackdown on undisclosed offshore accounts, which started in approximately 2009. Like the current initiative related to cryptocurrency, the offshore account crackdown involved the use of John Doe Summonses, which were issued to several foreign banks in Switzerland and other countries.
The IRS used the information garnered from these summonses to audit, and in some cases prosecute, U.S. taxpayers with undisclosed offshore accounts. It also rolled out the Offshore Voluntary Disclosure Initiative and, later, the Streamlined Filing Compliance Procedures, to allow individuals with undisclosed offshore accounts an opportunity to come forward voluntarily.
How is Cryptocurrency Taxed?
Cryptocurrency is taxed as “property,” similar to stock. If you own it for more than a year before you sell, you get favorable long-term capital gains treatment. For most people, long-term capital gains are taxed at a maximum of 15%. If you own it for less than a year before selling, then the gain is taxed like ordinary income.
Where is the IRS headed?
We can expect the IRS to issue more John Doe Summonses in the coming months and years. The information that it obtains through these summonses will presumably be used to initiate civil audits of those who have not reported their cryptocurrency transactions. In egregious cases, criminal prosecution may even be on the table, as we have seen in the offshore account arena.
Those who are concerned about the risk of criminal prosecution may wish to utilize the IRS Voluntary Disclosure Practice. Generally, using the voluntary disclosure procedures before the IRS learns of your non-compliance protects you from criminal prosecution. However, these procedures are not for everyone, as they involve onerous civil penalties and are not available to those who have income from illicit activities (e.g., drug-dealing, prostitution, money laundering, financial crimes, etc.).
For more information about your options for coming into compliance with your cryptocurrency transactions, contact the professionals in our IRS Representation and Defense Group, or call Naveid Jahansouz at 972-818-5300.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.