In an effort to address tax noncompliance related to the use of virtual currencies, commonly referred to as “cryptocurrencies,” the IRS recently sent letters to over 10,000 taxpayers with one or more cryptocurrency accounts. The letters informed the taxpayers of their obligation to report transactions involving cryptocurrencies, such as sales, exchanges, and other dispositions, including the use of cryptocurrency to obtain goods and services, as well as provided a date by which the taxpayers must respond to the letter—either to demonstrate their compliance with their reporting requirement or remedy any noncompliance. The reporting obligation applies regardless of whether an account is held in the U.S. or overseas.
To whom are the letters directed?
The letters were directed toward taxpayers who have one or more cryptocurrency accounts and who may not have met their U.S. income tax filing and reporting obligations for one or more tax years from 2013 to 2017. The IRS obtained this information through ongoing compliance efforts with digital wallet providers.
Why are the letters being sent?
The letters were sent to more efficiently enforce U.S. tax laws and to help taxpayers understand and meet their reporting obligations. For U.S. income tax purposes, cryptocurrencies are treated as property, not currency. Therefore, cryptocurrencies sales, exchanges, and dispositions are taxable events that require reporting on U.S. income tax returns.
The current broad noncompliance scenario is reminiscent of what prompted an IRS/DOJ effort in 2009 to address tax liability for undisclosed foreign bank accounts. That program, which offered offenders a series of reduced civil penalties and reduced the likelihood of criminal prosecutions, induced taxpayers to pay over $11.1 billion in back taxes, penalties, and interest. It also brought those offenders and their accounts back into the tax system for future years. Ten years later, it is clear that the international aspects of that program have actually changed the culture of the worldwide financial institution industry relating to compliance with tax laws.
In light of continued IRS budget cuts, the cryptocurrency letters were likely sent as the first step in a similar program to help IRS and DOJ bridge the gap in terms of enforcement. Down the road, the recipients’ responses to these initial letters will surely help the agencies prioritize their enforcement efforts by allowing them to identify individuals who may be willfully disregarding their reporting requirements.
What if I have received a letter from the IRS?
If you have received a letter from the IRS, you should consult with your tax advisor to confirm that you have complied with your reporting obligations as well as gather the necessary information for responding to the letter. If you have not, you should discuss with your tax advisor your options for remedying any noncompliance.