Beginning last year, the IRS has been looking at transactions involving cryptocurrency with an increased scrutiny. Taxpayers buying, selling, mining, or exchanging cryptocurrency should be aware of the interest the IRS has shown in the area, and the possible consequences for failing to report taxable gain stemming from its use.
The IRS investigation into cryptocurrency abuses began when a John Doe Summons was issued to Coinbase Inc. This summons required Coinbase to turn over large amounts of personal data on any user making a transaction with cryptocurrency between Jan. 1, 2013 and Dec. 31, 2015. Coinbase, the nation’s largest Bitcoin exchange, refused to submit to the summons. On March 16, 2017, Coinbase filed a petition in the Federal District Court for the Northern District of California to have the summons thrown out.
The IRS argued in support of their summons that the number of taxpayers reporting Bitcoin related items on electronically filed Form 8949 was suspiciously low. Form 8949 is the form on which taxpayers must report their disposition of capital assets. According to Coinbase, they service roughly 5.9 million registered users. However, the IRS reported that between Jan. 1, 2013 and Dec. 31, 2015 only 800 to 900 taxpayers reported Bitcoin related items on electronically filed Form 8949s.
Coinbase countered the IRS position by advancing several different arguments. Principally, Coinbase asserted that the search terms used by the IRS to determine the number of taxpayers filing Bitcoin related items on a From 8949 were vague, that Form 8949 is not the only place where taxpayers may report income from Bitcoin related transactions, and that a disproportionate number of Coinbase users may be filing paper returns. Additionally, Coinbase challenged the personal knowledge of the lead IRS official providing testimony to the court and argued that the government had not met their burden of proving a legitimate purpose for the summons.
Ultimately, the IRS won the day, as Judge Scott issued an order enforcing a reduced summons on Nov. 27, 2017. The summons, as allowed by the order, requires Coinbase to turn over to the IRS the taxpayer ID, name, birth date, address, certain records of account activity, and all periodic account statements for any user having made a transaction of at least $20,000 between the years 2013 and 2015. This excludes any users that purchased Bitcoin and subsequently had a Form 1099 filed by Coinbase. On February 23, 2018, Coinbase contacted 13,000 users to alert them that their information has been forwarded to the IRS in compliance with this summons.
In Notice 2014-21, the IRS states that cryptocurrency is subject to the same tax laws as other property. As with any other form of property, taxpayers will have a basis in cryptocurrency. Therefore, taxpayers exchanging cryptocurrency for cash, or even other property, may have a recognition event if the value of the cryptocurrency differs from the taxpayer’s basis. If the value of the cryptocurrency exceeds the taxpayer’s basis the taxpayer will experience taxable gain. If the value of the cryptocurrency is below the taxpayer’s basis the taxpayer will experience a loss. Additionally, mining cryptocurrency is considered a recognition event.
Furthermore, taxpayers failing to report gains from cryptocurrency transactions will be subject to tax penalties. For example, a taxpayer exchanging $100,000 of cryptocurrency, with $90,000 of built-in gain, for other property must report taxable income on this transaction. If the taxpayer fails to do so they may be subject to penalties for the understatement of tax. Gross misstatement of income and even fraud penalties may also apply to taxpayers underreporting taxable gains from cryptocurrency transactions.
There are several traps for the unwary when dealing with cryptocurrency. Taxpayers purchasing, mining, or exchanging cryptocurrency should consult with a tax professional. Chronic under reporting of cryptocurrency income can lead to longer statutes of limitations, back taxes, civil penalties, and in some cases even criminal charges. Should you have any questions regarding cryptocurrency, or any other complex tax issue please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com.