There have been a few developments since we last looked at cryptocurrency in April, 2017 (Are Bitcoin Users Cheating on Taxes? (Or Are They Just Confounded by the Rules?)). The IRS has increased tax compliance enforcement but unfortunately, guidance from the Internal Revenue Service has not kept up with the advances in the cryptocurrency world continuing tax reporting challenges.
In 2014 the IRS released their position regarding the taxation of cryptocurrency transactions in Notice 2014-21 (https://www.irs.gov/pub/irs-drop/n-14-21.pdf). The IRS notified taxpayers that:
- Cryptocurrency should be treated as property so sales will result in taxable gains/losses that may be ordinary income or capital depending on facts and circumstances.
- Receiving payment for services rendered or from the sale of goods in cryptocurrency should be treated the same as if payment was received in cash so the payment is taxable income.
- Mining cryptocurrency generates income upon receipt of the currency and this income may be subject to self-employment tax.
- Businesses paying vendors in cryptocurrency are subject to the Form 1099-MISC information reporting rules.
No additional guidance has been provided by the IRS since the above notice was released.
With the large increase in the value of Bitcoin (and other cryptocurrencies) during 2017 and the lack of tax reporting data provided to the IRS from trading platforms, taxing authorities believe that unreported taxable gains will be significant. Some trading platforms are providing sales data (but not gain/loss data) to the IRS if a customer has over 200 trades during the year that total over $20,000 in sales. Since many users of a platform may not have over 200 trades, their activity will go unreported.
Recently the IRS has increased its enforcement activities to increase tax reporting compliance. Earlier this year it successfully obtained a court order requiring Coinbase to provide client names, taxpayer IDs, addresses and transaction records (2013-2015) for over 13,000 users. Most likely the IRS will be submitting similar requests to other trading platforms. In addition, during March 2018, the IRS posted a rather ominous reminder (https://www.irs.gov/newsroom/irs-reminds-taxpayers-to-report-virtual-currency-transactions) on its website that virtual currency transactions are not exempt from tax reporting. The IRS “reminded” taxpayers that failure to report cryptocurrency income can lead to criminal prosecution and a $250,000 fine. On July 2nd the IRS announced a Virtual Currency compliance campaign and its intention to not offer any voluntary disclosure programs for noncompliance. The IRS intends to address noncompliance through “multiple treatment streams including outreach and examinations”. It is unclear how much of the IRS’s resources will be devoted to this campaign as the IRS has 38 other compliance campaigns announced since Jan. 2017 to manage plus the many changes required by the 2017 tax reform act.
Due to a lack of guidance, new tax reporting challenges have appeared:
- Since the IRS has determined that cryptocurrency is “property”, can taxpayers engage in tax-deferred exchanges under Internal Revenue Code section 1031? Congress has unintentionally answered this question when it passed the 2017 tax reform act in late December. Generally, effective Jan 1, 2018, only real property is eligible for 1031 exchange treatment. Unfortunately, this does not provide guidance for taxpayers that engaged in cryptocurrency exchanges prior to 2018.
- How should “hard forks” be treated for tax basis reporting? A “hard fork” occurs when there is a change to the underlying blockchain so a different version of the currency is created. Holders of the old version may receive an amount of the new currency.
- What are the tax consequences to investors and the business entities raising funds from these investors using “initial coin offerings”? Investors use real money or cryptocurrency to buy “tokens” from an entity seeking financing. These tokens can be resold, redeemed for products or redeemed for new cryptocurrency and may offer the investor a share in the enterprise’s profits. These unregulated offerings have become so popular that the SEC created a fake website (https://www.howeycoins.com/index.html) to entice and educate potential investors about the possibility of fraudulent activity.
It is unlikely the IRS will be issuing significant guidance in the near future. Unfortunately, it appears the IRS has chosen to devote its limited resources to enforcing compliance of existing rules, however ambiguous they may be, rather than offering more guidance to help taxpayers apply our tax laws to the new and ever-changing world of cryptocurrency.