Cryptocurrency and Virtual Currencies – Tax Consequences and Overview

With record breaking momentum and utilization of cryptocurrency, the IRS and United States Treasury Department is taking an aggressive look at individuals involved in virtual currency Investments, purchases, sales, and mining operations.  In a world where identity theft and security are always at risk, cryptocurrencies are taking the lead in financial innovation.  While the privacy stakes are high, the risks of financial crimes and illegal activity are also high.  FinCEN, The Financial Crimes Enforcement Network, is a United States Bureau that collects and analyzes information to help protect the United States from financial crimes, like money laundering, terrorist, and other financial crimes.  The fear is that people are using the anonymity to fund drug, money laundering, and terrorism activities which has increased the validity in the United States Law Enforcement Department's interest into the account holder's and individuals who are using the new financial network.  In addition to FinCEN, the Bank Secrecy Act is an Internal Revenue Service organization that collects information from financial institutions to collaborate with the United States to find money laundering and other financial crimes within the United States. 

IRS Civil Audits Heating Up

The IRS now has information regarding U.S. individuals who have cryptocurrency and are sending out automated letters to these individuals.  The letter from the IRS is numbered Letter 6174-A, and it states, “We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transaction involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.” 

IRS Letter 6174-A (6-2019)

IRS Letter 6174-A (6-2019)

It can be safely assumed that the IRS is issuing these letters in response to the big win against the third party cryptocurrency company, Coinbase.  In February of 2018, Coinbase notified many of its account holders that it had to provide the United States (3:17-cv-01431-JSC) with user information for tax purposes for years 2013, 2014, and 2015. The IRS is aggressively going after United States individuals who are using cryptocurrency and potentially not paying taxes on any gains, or on any taxable income received. 

Coinbase, is an electronic wallet, that can store Bitcoin, along with other cryptocurrencies.  In 2009, Satoshi Nakamoto created a network for an anonymous peer-to-peer electronic payment system.  The ledger for this system, rather than being maintained by a trusted third party like a bank, is publicly reported anonymously on a network ledger, which is called a blockchain.  The anonymity of the transactions creates another positive reason for its uses.    The information is protected with a private key, like a password, to access the account.  Bitcoin remains the most popular cryptocurrency on the market.  While Bitcoin may be the most popular, Facebook's founder Mark Zuckerberg also came out with a new cryptocurrency Libra and has had a fair amount of press regarding this new virtual currency.  In July of 2019 a G7 was held for Facebook's new cryptocurrency that it has proposed, Libra.  The G7 French Finance Minister Bruno Le Maire stated concerns regarding cryptocurrencies, saying, “We cannot accept private companies issuing their own currencies without democratic control.”  Governments worry that while tech companies are being innovative in e-commerce payment systems, that electronic currency could impact the economies and global markets and are proposing tight regulations. 

IRS Cryptocurrency Criminal Tax Cases Expected Soon

Don Fort, the Chief of the IRS's Criminal Investigation Division, recently said that the division is concerned about cryptocurrencies impact on tax administration because of the lack of visibility in the financial transactions, which increases the probability of fraud. Ford said that the Joint Chief of Global Tax Enforcement (J5) has been investigating cybercrimes and cryptocurrency and is expected to have successful criminal cases in the next year. The J5 is an international tax enforcement collaboration between the United States, Canada, the United Kingdom, the Netherlands, and Australia. 

While the outlook for virtual currencies and financial innovation continues to grow in popularity, the tax consequences and regulations will also continue to encroach on individuals and companies who are utilizing these currencies for use in purchases and investments.  So far, the IRS has increased the amount of time it invests in researching virtual currencies and litigation with Coinbase.  Notice 2014-21 gave taxpayers some guidance regarding rules and regulations surrounding virtual currencies.  In summary, if you invested in a cryptocurrency, or have a mining operation, you should be on the lookout for correspondence from the IRS regarding your involvement and make sure that you have properly reported all your income from virtual currency sources, including information returns (W-2s, 1099s). 

Before amending any returns or corresponding with a government agency, consult with a tax professional regarding the tax implications of your fact pattern with your use of virtual currencies to protect yourself against any penalties or potentially criminal consequences.