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Long Story Short - Is the IRS Watching Your Crypto Transactions?
The IRS is cracking down on bitcoin and other cryptocurrency holders who haven’t reported earnings or paid taxes on trades. In August, about 10,000 bitcoin owners will receive letters from the IRS requiring payment on any unreported cryptocurrency trades. IRS established a Virtual Currency Compliance Campaign addressing issues related to noncompliance on cryptocurrency. The Virtual Currency Compliance campaign focusses on “noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical.” IRS has conducted ongoing compliance investigations to find cryptocurrency holders and sent previous initial educational letters to taxpayers. Chuck Rettig, the IRS Commissioner stated, “the IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.” Last year, a court order for Coinbase, a cryptocurrency exchange platform, required the turnover of information to IRS, on around 14,000 accounts. The IRS targeted accounts on Coinbase who purchased or had sales of more than $20,000 worth of cryptocurrencies between the period of 2013 to 2015. The IRS had only received about 900 filing reports relating to cryptocurrency transactional gains or losses even though a large majority of Americans use regulated cryptocurrency exchanges such as Coinbase.
Amended Return: Taxpayers have an extended period, three and a half years, to file an amended return on earnings from cryptocurrencies sold before being audited by the IRS. Yates stated "until an audit is underway, you can try to file an amended return. For a lot of taxpayers that may be the way to go, especially if you file your returns yourself. Now, if you just didn't report, that's where you'll find yourself in trouble." Many taxpayers lack fundamental understandings of what is necessary to file, and the IRS has provided little guidance in regard to cryptocurrencies. Katya Fisher, practice group leader of the blockchain at Greenspoon Marder, stated “99% of people in crypto are ignorant, to some extent, of these issues. I don't blame them—these issues are very complicated, and we don't expect them to be tax experts."
Cryptocurrency Splits: The IRS has not provided specifics on paying taxes on cryptocurrency gains that have split such as Bitcoin which divided 70 times. It is difficult to track just how many cryptocurrency holders and traders owe taxes to the IRS, leaving some sense on leniency. A LendEDU survey showed that around 7% of respondents made transactions with cryptocurrencies. Nelson Yates, attorney at law firm Morgan Lewis, stated “it gets challenging is if you or somebody is day-trading and buying in and out; there's a host of issues relating to what part of bitcoin did you sell, how long did you hold it, what is the method for determining what's going in or out?" Regulating cryptocurrencies and finding traders who participate in large taxable transactions may prove difficult for the IRS.
Applicable to Gains: Taxes do not apply to cryptocurrency holders who have not sold any virtual currencies. Holders who virtual wallets have had gains in value, do not have to pay any taxes on these higher values until the currency is sold or exchanged for dollars. If a holder has lost money on sales in cryptocurrency markets, then they are able to use losses to offset income.
Taxable Property: The IRS sent out 10,000 letters to cryptocurrency traders who have not reported earnings. The IRS is taxing cryptocurrencies similar to property, while not providing much additional information to regulatory processes. In 2014, IRS guidance provided that if a cryptocurrency is sold after increasing in initial purchased value, the holder would have to pay capital gains on between 10% and 37% of total profits. Any taxpayer who has failed to report income or not paid taxes on selling cryptocurrencies such as Bitcoin, Litecoin, and Ethereum will receive a letter in August.
Tax Fraud: Cryptocurrency holders who do not accurately report earnings from trades are going to be held liable, incurring penalties as well as having to pay interest. Rettig, stated “taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest, and penalties.” The IRS noted that those who do not pay taxes on earnings will face criminal prosecution.
Government Interference: The IRS will continue to address compliance and enforce harsher punishments on those who go without reporting earnings from sales. The Trump Administration and White House have been vocal on their disapproval of cryptocurrencies and unregulated exchanges, insuring that additional regulations would be implemented. Steve Mnuchin, Treasury Secretary, stated that Libra, Facebooks in-development cryptocurrency, is “a national security issue." The IRS will be closely watching cryptocurrency exchanges and transactions to prohibit tax evasion and fraud.
Reminder: The IRS letters being sent out to 10,000 traders, remain as a generic reminder and do not yet indicate whether the person will be audited. It is necessary that taxpayers report earnings and pay taxes on any cryptocurrency sales made in the last few years in order to avoid an audit. The IRS announced, “U.S. persons are subject to tax on worldwide income from all sources including transactions involving virtual currency. IRS Notice 2014-21 states that virtual currency is property for federal tax purposes and provides information on the U.S. federal tax implications of convertible virtual currency transactions.” Transactional gains on cryptocurrencies sold need to be reported on tax returns but there is still time to file amendment returns to avoid audits or harsher punishments.