The IRS announced that it has begun sending letters to taxpayers with virtual currency (including “cryptocurrency”) transactions. This is part of a Virtual Currency Campaign being run by the IRS to ensure taxpayers are properly reporting income from these transactions. According to the IRS announcements, the mailing campaign began in mid-July and, by the end of August, more than 10,000 taxpayers will receive the letters. Names of taxpayers who potentially failed to properly report their virtual currency transactions were obtained through various compliance efforts.
The current IRS campaign
The current campaign involves sending 3 different educational letters, which require various types of responses:
- Letter 6174: IRS is aware the taxpayer has a virtual currency account and seeks to inform the taxpayer of its reporting obligations. If the taxpayer believes all income has been properly reported, no response is needed.
- Letter 6174-A: IRS is aware the taxpayer has a virtual currency account and may not have properly reported the transactions. Again, if all income has been properly reported, no response is necessary.
- Letter 6173: For one or more of tax years 2013-2017, the IRS is aware that the taxpayer had a virtual currency account and did not file a tax return, or a form or schedule related to virtual currency. This is the most severe of the letters – it requires that the taxpayer respond by either filing or correcting returns, or providing an explanation signed under penalties of perjury. If no response is received, the IRS may proceed to examine the taxpayer.
How does the IRS view virtual currency?
Virtual currencies such as Bitcoin and Ethereum are used as a medium of exchange, but they are not legal tender in any jurisdiction. As a result, the IRS (Notice 2014-21) considers virtual currency to be property, rather than currency, for tax purposes. A taxpayer who receives virtual currency as payment for goods and services must compute the fair market value of the currency at the time it is received and include that amount in taxable income. If a taxpayer receives virtual currency and then subsequently exchanges it for other items or money, it will be necessary to calculate gain or loss on the transaction (by comparing the basis of the virtual currency and the fair market value of the items received in exchange). The IRS notice indicates that gain or loss on virtual currency transactions could be capital or ordinary in nature, depending on the circumstances.
The challenge of recordkeeping/reporting
In order to ensure proper reporting, taxpayers dealing with virtual currency must maintain good records of their transactions. While these requirements are similar to those faced by individuals with traditional investments, the process is much more challenging in the area of virtual currency:
- Virtual currency exchanges do not necessarily provide users with 1099 reporting information. Even if a 1099 is not received, it is very possible that the user has income to report.
- High trade volume can make tracking onerous.
- Exchanges have been known to shut down, leaving users without access to their data.
- Virtual currency tax software is available, but it is not without limitations.
The IRS has urged taxpayers to take these letters seriously and has indicated that it will issue additional guidance on virtual currency in the near future.
UPDATE: IRS Steps Up Its Cryptocurrency Campaign
In addition to the 3 IRS letters we discussed in our earlier blog post, it has been reported that the IRS recently began sending taxpayers additional notices related to virtual currency transactions. These letters state that information reported by the taxpayer does not match the information reported by a 3rd party, such as a cryptocurrency trading exchange. As the letters indicate, the discrepancy does not necessarily result in additional tax due, and it may be the fault of the trading exchange, rather than the taxpayer. Nonetheless, taxpayers will want to take these letters seriously and determine what additional steps they must take.
For more information about how these developments may apply to your situation, please reach out to us at firstname.lastname@example.org or 800.899.3633.