The IRS, on July 2, 2018 through its Large Business and International division, announced that it will begin targeted audits and other enforcement actions in a few specific areas. Importantly, the area of virtual currency or "cryptocurrency" was singled out for one of these enforcement campaigns. Through these campaigns, the IRS develops increased knowledge and training regarding the targeted issue and attempts to increase the tax compliance (and revenues) from these areas. With regard to virtual currency, there is a growing sense among tax collectors (and tax professionals like this one) that non-reported income in this area is rampant. Just a few years ago, in its only significant statement on the matter the IRS ruled that virtual currency is treated as property for purposes of federal income tax purposes. See IRS Notice 2014-21. This means that each and every time a cryptocurrency is "exchanged" -- that is, used in a transaction -- there is a taxable transaction which occurs as if the cryptocurrency at issue were sold (similar to the sale of a share of stock). Gain or loss could result depending on the fair market value of the currency on the date of the exchange compared with the taxpayer's basis in the currency. The resulting gain or loss could be long-term or short-term capital in nature and could even be ordinary income or loss in proper circumstances. Through the recently announced campaign, the IRS will utilize general information outreach efforts and, of course, examinations.
This author was coincidentally asked to render an opinion on the subject of cryptocurrency taxation several years ago. My colleague and I reached the same conclusion that the IRS later did in IRS Notice 2014-21 -- the virtual currency is properly treated as property. This is opposed to being treated as "currency" within the meaning of the tax law such as U.S. dollars or the denominated currencies of other governments. The recipient of our opinion in that case was surprised and displeased to hear that result, as will be most cryptocurrency investors.
The cryptocurrency area is fraught with uncertainty from a worldwide tax perspective (and also from a financial investment risk perspective). U.S. taxpayers (citizens, including those citizens living abroad, and other persons resident in the U.S.) are taxable on their worldwide income from whatever source. This would include cryptocurrency transactions, wherever and however they occurred. The recent U.S. tax law changes in the Tax Jobs and Cut Act of 2017 did not affect this worldwide taxation principle with respect to individuals. Information reporting regarding cryptocurrency transactions is relatively secretive and, indeed, that is a common reason that cryptocurrency users are drawn to its use in the first place. The IRS, however, has made inroads in requiring reporting from certain large cryptocurrency exchanges. With those reports, the IRS can begin to identify taxpayers with unreported transactions for examination. Failure to report taxable income, if discovered, can at least result in civil penalties and, in the proper circumstances, fraud or criminal penalties (perhaps resulting in the cost that no one wants to incur - loss of personal freedom for some period).
The IRS sometimes carries out formal voluntary disclosure programs, and they have done that over the past several years with regard to unreported foreign income and assets of U.S. taxpayers. That voluntary disclosure program, which was revised from time to time and extended, is now slated for termination in September, 2018. Interestingly, the IRS stated in its announcement that they were not contemplating such a voluntary disclosure program in the case of cryptocurrency. Voluntary disclosure programs typically allow a taxpayer to "come clean" without fear of overly burdensome monetary penalties or criminal prosecution. Even in the absence of a formal voluntary disclosure program, however, it is still possible to informally approach the IRS and achieve a reasonably favorable result for the negligent taxpayer. That result will include the payment of taxes and probably relevant civil penalties, but criminal prosecution can typically be avoided. Approaching the IRS in this manner and for these purposes, however, is a complex process that should only be undertaken with the assistance of competent tax counsel and only after a thorough examination of the relevant facts.
The IRS is not alone in its heightened interest in the utilization of cryptocurrency around the world. Many jurisdictions are confronting the task of tracking down those who go beyond tax law violations and use cryptocurrency in their otherwise nefarious enterprises. See a recent report on the IRS joint efforts on this front as reported here. Of course, the more things change, the more things stay the same - criminals involved in big-money enterprises always leave tax evasion in their track.
For the taxpayer that believes they have unreported or inaccurately reported cryptocurrency transactions, they should consider what corrective course should be taken. Those taxpayers should probably consult with a tax attorney first to assess their relevant civil and even criminal exposure - an attorney will provide an additional measure of confidentiality protection that will not be available by way of contact of a different tax professional, including a CPA. If you have any questions regarding cryptocurrency tax issues, please contact Steve Phillips at email@example.com