IRS Criminal Investigation division Chief Donald Fort stated recently at the Federal Bar Association meeting on Taxation in Washington, D.C., that virtual currencies are an immediate concern to the IRS and a focus of the Criminal Investigation group. Fort outlined three areas of tax enforcement focus involving the use of virtual currency:
- The absence of taxpayers to report gains on the disposition of virtual currencies;
- Use of cryptocurrency accounts as alternatives for other financial accounts, such as bank accounts;
- Use of cryptocurrency in business transactions that are unreported, including payment of wages and goods and services.
In 2014 the IRS issued Notice 2014-21 (2014-16 I.R.B. 938), which describes how the IRS applies U.S. tax principles to transactions involving virtual currency. According to the IRS, virtual currencies that can be converted into traditional currency are considered “property” for tax purposes, and a taxpayer can have a gain or loss on the sale or exchange or a virtual currency, depending on the taxpayer’s cost to purchase the virtual currency (i.e., tax basis). Thus, under general tax principles applicable to property transactions, the sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally have tax consequences that could result in tax liability. The notice applies to individuals and businesses that use virtual currencies.
According to the IRS, taxpayers who have engaged in any of these virtual currency transactions and have not properly reported the virtual currency transactions have failed to comply with internal revenue laws, and, when appropriate, can be liable for penalties and interest. In addition, the IRS recently announced that those dealing in large amounts of cryptocurrency may also be subject to criminal prosecution, should they fail to correctly report the income tax consequences of digital currency transactions. Criminal charges could include tax evasion and filing a false tax return. Taxpayers convicted of tax evasion may be subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000. The following virtual currency transactions must be reported to the IRS:
- Wage, salary, or other income paid to an employee with virtual currency is reportable by the employee as ordinary income, subject to employment taxes.
- Virtual currency received by a self-employed individual in exchange for services is ordinary income subject to self-employment tax.
- Virtual currency received in exchange for goods or services by a business is reportable as ordinary income.
- Gain on the sale of property held as a capital asset in exchange for virtual currency is reportable as a capital gain.
- Gain on the exchange of virtual currency for other property is generally reported as a capital gain if held as a capital asset and as ordinary income if it is property held for sale to customers in a trade or business.
- Payments made in virtual currency are subject to information reporting requirements to the same extent as payments made in real currency or instruments denominated in real currency.
New York Cryptocurrency Investigation
On April 17, New York Attorney General Eric T. Schneiderman launched the Virtual Markets Integrity Initiative, a fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or “crypto” currencies like bitcoin and ether. As part of a broader effort to protect cryptocurrency investors and consumers, the Attorney General’s office sent letters to 13 major virtual currency trading platforms requesting key information on their operations, internal controls, and safeguards to protect customer assets. As the letters explain, the initiative seeks to increase transparency and accountability as it relates to the platforms retail investors rely on to trade virtual currency, and better inform enforcement agencies, investors, and consumers.