If you have traded Bitcoin or other crypto-currencies, you probably know that their taxation may be as uncertain as your potential for reward or loss. Since 2014, the Internal Revenue Service (IRS) has publicized how it believes these investments should be treated for US federal income tax purposes. If you have failed to report your virtual currency transaction, the result in Coinbase, a recent IRS “John Doe” summons enforcement case, should convince you that it is time to ensure you are compliant with tax laws. The IRS may be coming for your Bitcoins!
IRS Guidance – Bitcoins Are Property
In IRS Notice 2014-21, 2014-16 IRB 938, the IRS explained that so-called “virtual currencies” that can be exchanged for traditional currency are “property” for federal income tax purposes. As such, a taxpayer must report gain or loss on its sale or exchange, measured against the taxpayer’s cost to purchase the virtual currency. In the notice, the IRS also made clear that “virtual currencies” are not currency for Internal Revenue Code (IRC) section 988 purposes.
Now that the IRS has made its position known, it is looking for taxpayers who are not following its 2014 guidance. Further, the IRS views trades in crypto-currencies as carrying a high risk of tax evasion; this is due to the level of anonymity involved and the lack of third-party reporting mechanisms. For example, a recent report by the Government Accountability Office has taken the view that crypto-currencies “may be attractive to parties seeking to . . . move or conceal money obtained by illegal means.”
Coinbase, Inc. is a very prominent Bitcoin trading platform used by millions of transactors. In late 2016, the IRS served Coinbase with a “John Doe” summons seeking the details of its customer’s transactions. In response, Coinbase refused to disclose its customers’ information and challenged the summons in court. (We have previously reported on the case here, here and here.)
On November 29, 2017, a federal court in San Francisco ordered Coinbase to release certain customer information to the IRS. See United States v. Coinbase, Inc. 2017 WL 5890053 (N.D. Cal. 2017). The court ruled that Coinbase must turn over the details of all its Bitcoin customers who had transactions greater than $20,000 between 2013 and 2015. The result of the court’s order is that Coinbase will provide information for millions of transactions made by nearly 15,000 customers.
According to the IRS, the majority of Coinbase’s customers implicated in the court’s order have failed to report their dealings in Bitcoin for tax purposes. On February 23, Coinbase informed customers that it will be turning over the information to the IRS within 21 days or by March 16.
What now? If you were a Coinbase customer covered by the court order you should: (1) contact your tax lawyer immediately about your compliance options, including voluntary disclosure; (2) consider filing amended returns for 2013 through 2015, the years covered by the court’s order; (3) determine if you have any other exposure for failure to report the transactions (e.g., criminal and FBAR liability); and (4) preserve all information relevant to your failure to originally report any income from those transaction and the reasons why you did not report (e.g., that you relied on advice from a tax professional). These are all best practices even if you are not a Coinbase customer covered by the court’s recent order.
The IRS is targeting transactions in virtual currencies. While these investments have potential for great gains, they also carry great risks if not reported correctly for tax purposes. If you are an investor in these transactions, it is in your best interest to know the boundaries of the law.