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Infrastructure Bill Provision Expands Cryptocurrency Reporting Requirements

On August 1, 2021, the US Senate unveiled the draft text of the Infrastructure Investment and Jobs Act (Bill), a highly anticipated $1 trillion infrastructure package negotiated by the White House and a bipartisan group of senators. As discussed below, the Bill includes a provision (Section 80603) that, if enacted in its current form, would amend the Internal Revenue Code (Code) to extend certain reporting requirements for transactions involving digital assets, including cryptocurrencies such as Bitcoin and Ether and other forms of digital tokens. The provision, which would generally go into effect on January 1, 2023, is intended to address a “tax gap” resulting from the underreporting of cryptocurrency transactions.

BROKER REPORTING

Code Section 6045 generally imposes reporting requirements on “every person doing business as a broker” with respect to sales affected by the broker on behalf of its clients. Under current law, such reporting is currently limited to sales of corporate stock, interests in trusts and partnerships, debt obligations, certain commodities and various associated derivatives. Pursuant to regulations, such sales are reported by the broker on Form 1099-B and the information required to be reported includes identifying information about the taxpayer and the property sold, the sale date and gross proceeds of the sale—and only with respect to the sale of a “covered security,” the adjusted basis of the property sold and the character of the gain or loss on the sale (i.e., long- or short-term capital gain).

For purposes of 1099-B reporting, a “broker” is defined to include a “dealer, a barter exchange, and any other person who (for a consideration) regularly acts as a middleman with respect to property or services.” A typical example of a broker subject to 1099-B reporting is a brokerage firm that facilitates transactions for customers in stocks, bonds and/or commodities.

The Bill expands the definition of a broker to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Unless otherwise provided by the US Department of the Treasury’s regulations, a “digital asset” means “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by [Treasury].” A cryptocurrency exchange would be considered a broker under this language.

The “basis” reporting under Section 6045 only applies to “covered securities.” Under current law, the term covered securities generally includes corporate stock shares, debt obligations, certain designated commodities (and derivatives thereof) and other financial instruments. The Bill would expand the definition of covered securities to include any “digital asset.” Accordingly, brokers subject to Section 6045 will be required to report the adjusted basis and the character of the gain or loss upon the sale of digital assets, including utility tokens, stablecoins and asset-backed tokens.

BROKER-TO-BROKER AND BROKER-TO-NON-BROKER TRANSFER REPORTING

Under current law, Code Section 6045A imposes additional reporting requirements that are generally applicable to the transfer of covered securities by one broker to another. Specifically, the transferor broker must [...]

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Key Takeaways | Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW

During a recent program discussing the latest government enforcement efforts related to cryptocurrency, we spoke with Gary Alford, one of the leading Internal Revenue Service (IRS) agents in their crypto enforcement efforts, Perry Carbone, Chief of the White Plains Office (US Attorney’s Office – SDNY) and Andy Cole, former Director of Specialist Investigations at HM Revenue & Customs in the United Kingdom, about how investors and companies in the virtual currency industry should address enforcement actions. Below are key takeaways from the conversation.

ENHANCED ENFORCEMENT – UNITED STATES

  • The time to act is now. The IRS and the US Department of Justice (DOJ) are collecting virtual currency data at a rapid pace while simultaneously moving forward with tax enforcement cases. The IRS Criminal Investigation (IRS-CI) revamped its operations to “do more with less” using new technology that will move investigations at a faster pace.
  • The IRS joined its civil and criminal units through Operation Hidden Treasure and is also working with outside experts in the field—along with specially-trained IRS agents—to pursue tax enforcement and asset seizure. This is a key agenda item for the US Department of the Treasury and is not going away any time soon.
  • The IRS and the DOJ expect taxpayers to comply voluntarily with all tax obligations. Despite these recent developments, US taxpayers have limited guidance from the IRS. Engaging with professionals in the space to evaluate the options available to taxpayers is crucial to assessing and ensuring compliance with cryptocurrency taxation.

INTERNATIONAL EFFORTS

  • Global collaboration is nothing new, but it is now on the rise. Agencies around the world are enhancing their cross-border information and resource sharing to investigate tax crimes efficiently and effectively. The J5, an important component of this global collaboration, is prepared to pool some of the world’s most sophisticated data analytical tools so that intelligence can be screened, searched and/or identified.
  • The Organisation for Economic Co-operation and Development (OECD) and its governing body will likely start requiring cryptocurrency exchanges to collect customer due diligence information. The window of anonymity around cryptocurrency transactions has closed rapidly in recent years.
  • The global Common Reporting Standard (CRS) has been in force since 2017. Under the CRS, tax authorities of over 100 countries (including most of the traditional “tax havens”) automatically exchange tax, account and payment information with each other in order to assist in tax collection and enforcement action.

FOR INDIVIDUALS

  • Moving forward, the “knowledge and willfulness” element needed for criminal cases will be much easier for the DOJ to prove because the “virtual currency question” is now at the top of Form 1040. The prominent location of this question is “a game changer” for criminal tax prosecutions.
  • Cryptocurrency tax crimes are no longer “add on” charges to other criminal prosecutions, such as narcotics or fraud crimes. The DOJ expects to bring independent cryptocurrency criminal tax cases and take these prosecutions to “the next level,” including prosecutions of more routine tax matters.
  • Individuals serving as board members on behalf [...]

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Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW

On June 28, 2021, McDermott held a webinar presentation titled “Cryptocurrency Global Tax Enforcement: What Investors and Companies in the Industry Need to Know NOW.”

Topics during this webinar included:

  • How to address the tax consequences of past virtual currency transactions, including potential voluntary disclosure considerations.
  • How to protect your business from a US Department of Justice (DOJ) or UK investigation, including compliance updates to address this risk.
  • Law enforcement perspectives and updates from the IRS, DOJ and a former high-level director at HM Revenue & Customs.
  • How to respond to an IRS letter, including potential civil resolutions.
  • How to respond to a DOJ or a UK Serious Fraud Office (SFO) inquiry, summons, subpoena, search warrant or a whistleblower complaint.

A link to the webinar is available here. A link to the webinar’s slides is available here.




Biden Administration Proposals Will Greatly Enhance IRS’ Ability to Identify Cryptocurrency Transactions

The Biden Administration and the Internal Revenue Service (IRS) continue to focus heavily on cryptocurrency tax enforcement issues. On May 20, 2021, the US Department of the Treasury (Treasury) released the American Families Plan Tax Compliance Agenda, a 22-page report detailing tax compliance measures that are to be included as part of US President Joe Biden’s American Families Plan. The report sets forth a number of initiatives designed to “close the tax gap,” identify the underreporting of tax liabilities and detect tax evasion. These measures, which are part of an $80 billion proposal for the IRS, would significantly enhance the agencies’ ability to address the challenges involved with finding taxes that result from virtual currency transactions.

The Treasury’s report notes that “[c]ryptocurrency already poses a significant detection problem by facilitating illegal activity broadly including tax evasion.” To address this issue, the Biden Administration is proposing “additional resources for the IRS to address the growth of cryptoassets.”

Most notably, the Biden Administration is proposing enhanced reporting requirements for domestic and foreign financial accounts that specifically address cryptocurrency. Financial institutions, including “cryptoasset exchange accounts and payment service accounts that accept cryptocurrencies” would be required to submit third-party annual reports of all “gross inflows and outflows” from business and personal accounts to the IRS using a form similar to the IRS 1099-INT. Additionally, “businesses that receive cryptoassets with a fair market value of more than $10,000 would be reported on” in a manner similar to how cash transactions are reported on Currency Transaction Reports. These new reporting requirements would dramatically increase the IRS’ ability to identify and detect unreported cryptocurrency transactions.

The report also reemphasizes the need to devote additional funding to the IRS. The Biden Administration is seeking $80 billion in additional funding so that the Treasury and IRS can, among other things, hire “new specialized enforcement staff” and “revitalize[e] the IRS’s examination of large corporations, partnerships, and global high-wealth and high-income individuals.”

Additionally, the Biden Administration plans to overhaul the IRS’ IT systems and capabilities. These IT enhancements are designed to “help support a staff capable of deploying new analytical techniques” and “developing machine learning capabilities [that] will enable the IRS to leverage the information it collects to better identify tax returns for compliance review.” Given the inherent difficulties in identifying cryptocurrency users who have failed to comply with the internal revenue laws, increased data collection and analytics capabilities would be invaluable for the IRS.

The IRS has already been ramping up its cryptocurrency tax enforcement efforts by issuing John Doe summons to various cryptocurrency exchanges, working with industry experts and foreign law enforcement. If implemented, the American Families Plan Tax Compliance Agenda would provide the IRS with extensive new tools and resources for these ongoing enforcement activities.

Practice Point: If you have engaged in cryptocurrency transactions, now is the time to analyze whether you have any civil or criminal exposure and prepare for a government inquiry by gathering all of your transaction records. For [...]

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Finding John Doe, Part II: IRS Secures Another Victory to “Root Out” Virtual Currency Tax Noncompliance

The Internal Revenue Service (IRS) has scored another significant victory in its rapidly increasing virtual currency tax enforcement efforts. On May 5, 2021, the US District Court for the Northern District of California entered an order authorizing the IRS to serve a John Doe summons on popular cryptocurrency exchange, Payward Ventures Inc. d/b/a Kraken (Kraken). Specifically, the court’s order grants the IRS permission to serve a John Doe summons on Kraken in order to obtain information on US taxpayers who conducted the equivalent of at least $20,000 in total transactions for each year from 2016 to 2020.

If the IRS follows its playbook from the Coinbase summons, its victory here and with the Poloniex summons (upheld by a court in Massachusetts a few weeks ago), will likely result in thousands of US taxpayers receiving a letter from the IRS regarding their virtual currency transactions. As noted in its response to the court, over the past few years the IRS has learned a great deal about analyzing these transactions and is in possession of information from foreign virtual currency exchanges it’s also analyzing. This victory, coupled with the IRS’ increased knowledge of virtual currency transactions, is a big step in its efforts to, as stated in the IRS’ court filing, “root out tax noncompliance.”

As we previously noted in “Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency,” the court ordered the government to submit a response explaining its need for the information requested in its summons to Kraken. The government’s response indicates that the IRS has made significant progress in its analysis of summoned data from other cryptocurrency exchanges, such as Coinbase, and its ability to follow leads in the cryptocurrency marketplace. The court’s order approving the summons significantly reinforces the strength of the IRS’ crypto pursuit. These efforts are not solely focused on identifying tax noncompliance at a single exchange like Kraken but to identify the conduct for individuals transacting in cryptocurrency with Kraken accounts who may have additional accounts at other exchanges.

In citing its need for additional information to the court, the IRS expressly stated that in its experience from processing the Coinbase summons information, it has learned that taxpayers will use aliases, false addresses, post office boxes, fictitious entity names or other means to disguise their true identity. Taxpayers who create and use false information are more likely to evade their taxes, the IRS argued. The summons approved by the court requires Kraken to produce extensive records and data regarding its accountholders. Among other things, the summons requires Kraken to produce the following for each US-based account with at least $20,000 in annual transactions:

  • Account registration records and user profile information, including name, date of birth, taxpayer ID number, physical address, email address and telephone number
  • History of any IP addresses used to access the account
  • Payment [...]

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IRS Releases Guidance on Cryptocurrency Hard Forks

On April 9, 2021, the Internal Revenue Service (IRS) released Chief Counsel Advice memo 202114020 (Hard Fork CCA), which details the potential tax consequences for taxpayers who held Bitcoin prior to the August 1, 2017, Bitcoin hard fork. While the Hard Fork CCA concerns the taxation of a particular cryptocurrency transaction, it has additional significance because it adds to the limited guidance available regarding the proper taxation of cryptocurrency more generally.

IN DEPTH

A cryptocurrency hard fork occurs when the blockchain on which cryptocurrency transactions are recorded permanently splits. The holder of the cryptocurrency generally has no control or notice that the hard fork is about to occur. The result is two separate blockchains with two separate sets of rules for recording transactions.

Bitcoin underwent a hard fork on August 1, 2017, and resulted in two separate sets of protocols for Bitcoin, as well as a new cryptocurrency called Bitcoin Cash. The result of this hard fork was that individuals holding Bitcoin in a distributed ledger now held a unit of Bitcoin Cash for each unit of Bitcoin previously held.

The Hard Fork CCA reached two conclusions concerning the Bitcoin hard fork. First, it determined that a taxpayer who received Bitcoin Cash because of the hard fork has gross income pursuant to Internal Revenue Code (IRC) section 61. Second, it determined that the date of receipt and fair market value of the income depends on when the taxpayer obtains dominion and control over the Bitcoin Cash. The Hard Fork CCA relies on the statutory language of IRC Section 61(a)(3) and the well-established case law of Commissioner v. Glenshaw Glass Company (348 U.S. 426, 431 (1955) in reaching this result. Those sources define gross income as “all income from whatever source derived,” and provide that all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion are included in gross income. The Hard Fork CCA also concludes that an impacted taxpayer gains dominion over Bitcoin Cash when they have the ability to sell, transfer or exchange the Bitcoin Cash.

Despite the fact that the Hard Fork CCA deals specifically with the consequences of the Bitcoin hard fork, the dearth of IRS guidance on the taxation of cryptocurrencies means the Hard Fork CCA will likely have broad importance to taxpayers who invest in other cryptocurrencies and similar digital assets. Most taxpayers hold cryptocurrencies through a cryptocurrency exchange platform. Coinbase, for example, which recently underwent a highly publicized initial public offering (IPO) and IRS summons for information concerning its participants, is one of the most popular cryptocurrency exchanges. (Additional detail regarding the Coinbase summons is available on our Tax Controversy 360 blog.) After a hard fork, some exchanges immediately adopt the new cryptocurrency and permit its use on the exchange; however, others only do so after a period of evaluation, if ever. The Hard Fork CCA takes the position that a taxpayer who privately holds their Bitcoin using a private key to [...]

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DOJ and IRS’ Analysis of Crypto Records and Work with Private Experts and International Partners Leads to Arrest

US law enforcement continues to make no secret of their efforts to work closely with experts and overseas partners to prosecute those involved in virtual currency transactions who attempt to rely on its purported anonymity to commit financial crimes. Tuesday’s arrest of Roman Sterlingov, a dual citizen of Russia and Sweden and alleged operator of Bitcoin Fog, in Los Angeles is a clear case that these efforts are paying dividends. In a criminal complaint filed by the US Attorney’s Office for the District of Columbia, Sterlingov is accused of laundering hundreds of millions of dollars’ worth of bitcoin. According to a statement of facts accompanying the complaint filed in the District of Columbia, Sterlingov was allegedly running “an illicit bitcoin money transmitting and money laundering service.” (Case 1:21-mj-00400-RMM Document 1-1 Filed 04/26/21.) Notably, investigators from the Internal Revenue Service (IRS) and Federal Bureau of Investigation (FBI) were able to obtain records of Sterlingov’s True Name accounts at several cryptocurrency exchanges. Investigators also analyzed bitcoin transactions, email records, financial records and internet service provider records. The investigation and arrest come at a time when the IRS, together with other enforcement agencies, are taking a hard look at cryptocurrency activity and have recently issued John Doe summonses to two virtual currency exchanges.

The collaboration with private experts and international partners is clear from the press release issued by the US Department of Justice (DOJ). In recognizing the many agencies that assisted in the investigation, the DOJ specifically stated that essential support was provided by Excygent, which is described on its website “as a highly specialized, professional services firm that assists organizations in both the public and private sectors with cybercrime investigative and analysis capabilities.” The DOJ also listed several US agencies that provided invaluable assistance and went on to include international partners: Europol, the Swedish Economic Crime Authority, the Swedish Prosecution Authority, the Swedish Police and the General Inspectorate of Romanian Police, Directorate for Combatting Organized Crime and the Directorate for Investigating Organized Crime and Terrorism. This ability to collaborate successfully will most likely serve as a blueprint for future investigations.

Practice Point: As we noted in our blog post, “Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency,” the time is now for those who have engaged in a virtual currency transaction to assess any potential tax and criminal implications, and businesses in this industry should carefully review their policies and processes to ensure that they address potential tax avoidance and anti-money laundering risks associated with their operations. The IRS is working closely with its new partners (i.e., industry experts and foreign law enforcement) to address any noncompliance. As announced recently by US President Joe Biden, he plans to give them the resources to do more on enforcement.




Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency

The Internal Revenue Service (IRS) is stepping up its virtual currency enforcement, and taxpayers who have engaged in a cryptocurrency transaction should immediately assess any potential tax implications as the IRS has recently issued two John Doe summonses to popular exchanges. These are the first it has issued in about three years, sending a very clear signal that the IRS is ready to tackle what it believes to be a continuing noncompliance. A US Federal District Court in Massachusetts upheld the summons issued to Circle Internet Financial Inc., including the popular cryptocurrency exchange Poloniex, while a US Federal Court for the Northern District of California required the government to submit a response explaining its need for the information requested in its summons to Kraken. (See: In re Tax Liability of John Does, No. 21-cv-2201, ECF No. 8 (N.D. Cal. Mar. 31, 2021)).

Filed on April 14, 2021, the government’s response provided numerous examples of how the data received in the Coinbase summons required additional requests in order for the exchange to locate actual taxpayers. The response argued that the need for multiple follow-ups defeated the purpose of the summons. It also described how information in Kraken’s possession, such as accountholder telephone numbers and email addresses, will facilitate the IRS’s ability to utilize relevant cryptocurrency platform data in its possession that was received from other sources relating to foreign-based cryptocurrency exchanges. Noting the potential for abuse by an accountholder, the response provided an example of an individual falsifying their identity as the basis for its need for complete account history in order to catch these issues. In addition, the response stated, “[m]atching the IP addresses for Kraken users to IP addresses and other data points in the IRS’s information will allow the IRS to link substantive account information from multiple sources for a single individual taxpayer and make a more accurate initial determination of whether that individual is in compliance with the internal revenue laws.”

It remains to be seen how the court will react to the government’s response. What is clear, though, from the response and the accompanying affidavit is that the IRS has made significant progress in its analysis of this data and its ability to follow leads. As a result, now is the time for individuals involved in these transactions to consult a tax professional to determine if they have any tax liability or potential exposure, including criminal exposure. After the Coinbase summons, the IRS issued 10,000 letters to taxpayers regarding virtual currency transactions. In the wake of these summonses, and potentially others, it is only a matter of time before the IRS reaches out to thousands of other taxpayers.

It is also clear that the enforcement arm of the IRS is working very closely with its counterparts around the world. The need for email addresses and phone numbers mentioned above to use foreign data certainly drives this point home. Even more so, as a precursor of things to [...]

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Are Crypto Loans Taxed as Loans?

Transactions involving the borrowing and lending of units of virtual currency (or crypto loans) are increasing in number and type. Lacking Treasury or IRS guidance with respect to crypto loans, potential tax issues that arise from these transactions must be analyzed and understood in accordance with broad, general tax principles established by case law and based on government guidance developed in other tax areas.

Access the full article here.




Taxation of Virtual Currency Staking Activities

Stakers—taxpayers involved in proof of stake (PoS) validation of blockchain transactions—are operating in uncharted tax waters. Treasury and the IRS have provided no guidance regarding when or whether staking rewards are included in taxable income. This article reviews various considerations that may help stakers document activities, rewards and expenses that support their federal and state tax positions.

Access the full article here.




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