IRS Continues To Warn Virtual Currency Users

Just in time for tax season, the Internal Revenue Service issued another reminder to taxpayers last week urging them to report virtual currency transactions on their income tax returns.  While the IRS first published guidance back in March of 2014 announcing that it will treat convertible virtual currency, such as bitcoin, as property for federal income tax purposes, the Service’s new reminder emphasizes the consequences of failing to report these transactions.  This notice points out that failing to properly account for virtual currency transactions can result in audits and possible liability for penalties and interest.  The Service also observed that “[i]n more extreme situations” taxpayers could be prosecuted criminally “for failing to properly report the income tax consequences of virtual currency transactions.”

The new release from the IRS underscores their ongoing efforts to understand and investigate the use of virtual currencies by U.S. taxpayers.  For example, the release states that currently there are more than 1,500 “known virtual currencies.”  The IRS also raises their concern that because “virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS.”  These observations should serve to remove any doubt that the IRS is interested in ferreting out virtual currency transactions and punishing taxpayers who fail to report such transactions.

This serious concern with the potential for virtual currency-focused tax evasion is not merely a passing curiosity by rank-and-file IRS agents, but extends to the top of the Department of the Treasury.  U.S. Treasury Secretary Steven Mnuchin recently expressed concern that cryptocurrencies, another term for virtual currencies, could become the digital equivalent of an anonymous Swiss bank account.

Secretary Mnuchin’s January warning was followed by Coinbase’s February 23rd announcement to customers that it was producing “certain limited categories of information from the accounts of approximately 13,000 customers” to the IRS within 21 days, following contested litigation with the government and a court order.  While Coinbase succeeded in limiting the IRS’s initial request for account records of approximately 500,000 customers down to 13,000, the Service has received, or will be soon receiving, a treasure-trove of data including the “taxpayer ID, name, birth date, address, and historical transaction records for certain higher-transacting customers during the 2013-2015 period.”  Coinbase customers, and cryptocurrency users more generally, should seek advice to ensure compliance going forward and to address any historical non-reporting of transactions.

Clarification to the IRS Whistleblower Program may incentivize more tips

Not only will IRS agents be on high alert for virtual currency-focused tax evasion, but Congress recently provided added incentive for potential whistleblowers to expose tax fraud and evasion, including schemes involving cryptocurrency.  The Bipartisan Budget Act, signed into law on February 9, 2018, clarified the definition of “collected proceeds” under the IRS Whistleblower Program.  Prior to the act, the IRS interpreted that term to exclude criminal fines and amounts recovered by civil forfeitures collected by the government outside the tax code.  As a result, the IRS’ previous position would prevent whistleblowers from sharing in a percentage, between 15-30%, of the money the IRS recovered based on the whistleblower’s tip, merely because the money was recovered through a criminal prosecution or forfeiture proceeding instead of the tax code’s collection provisions.  This served as a disincentive for whistleblowers with information on the most egregious violations, including schemes involving foreign bank accounts and virtual currency, because those cases would likely be investigated criminally by the government.  The definition of “proceeds” under Section 7623(c) of the Internal Revenue Code now specifically includes money the IRS recovers through criminal fines, civil forfeitures, and violations of reporting requirements.  Thus, tax whistleblowers are no longer potentially constrained in their recovery based on whether the IRS decides to use the tip to conduct a criminal investigation, forfeiture case, or a civil audit.

For more information, please contact Matt Mueller at mmueller@wiandlaw.com or 813.347.5142.  Matt is a former federal prosecutor focusing his practice on white collar defense, including tax, health care, and securities matters.