By Gina Gatchell,
Director
The cat and mouse chase which has evolved over the years since the first virtual currency emerged is turning into a large-scale operation. In March 2021, the IRS civil office of fraud enforcement partnered with the agency’s criminal investigation unit launching “Operation Hidden treasure”.
The enormous popularity of virtual currency has grown from what was originally the underworld criminal activities to mainstream use and acceptance of virtual currencies. Popularity has stemmed from its ability to provide anonymity, the removal of any intermediary, dramatically reduced fees, convenience, safety of the currency (there being no physical asset to lose such as cash). There are thousands of virtual currencies and these are especially popular in the United States.
Many fledgling currencies however the financial regulatory authorities around the world have been actively pursuing these currencies for what is now decades since the first virtual currency appeared in 2009. This was probably Bitcoin, although it is cited that others were in existence.
Trouble has been brewing for taxpayers dealing in virtual currencies for quite some time. In 2021 alone, the IRS has been actively pursuing records from dealers as part of a campaign addressing tax cheats which are costing the US economy an estimated US $1 trillion a year[1].
So far in 2021 we have seen the IRS seize the cryptocurrency records of a US taxpayer, James Harper, whose assertion that his constitutional rights had been violated[2] was dropped when the U.S. District Court for the District of New Hampshire cited the Anti-Injunction Act and he is now appealing.
Just last week, the IRS has received permission to serve John Doe Summons on masses of taxpayers dealing in virtual currencies.
This means that the IRS has authority to draw the records of investors in virtual currencies from the virtual currency company to see whether they have complied with their US tax obligations.
The other C word on everyone’s lips in 2021 is cryptocurrency… coronavirus being the first one.
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.
The European Banking Authority defines virtual currency as ‘a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a flat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically.
Three categories of virtual currency exist:
- closed virtual currencies including currencies used in gaming and exchanged between multiple players. These have no value outside the game.
- Single flow virtual currencies for example airline miles and Amazon Coin – used to buy products and/or services from a company, but nonexchangeable and worthless for any other purchases.
- Convertible virtual currencies which can be purchased and sold on different exchanges and including the most well-identified one Bitcoin.
Cryptocurrencies are the subset of convertible virtual currencies and these are digital currencies which are encrypted using cryptography to secure transactions.
This has been reflected in new disclosures on Forms 1040 US Individual Income Tax Return and 1040NR US Non-resident Income Tax Return. These first came to light on the draft forms late in 2019 together with Revenue Ruling 2019-24 addressing the classification of cryptocurrency as gross income.
Recent FAQs on the IRS website led to confusion and uncertainty around whether taxpayers should report the purchase of virtual currency and some rumblings within the tax professional community, since the taxpayer signs under penalties of perjury whether they have completed their tax return truthfully. The taxpayer advocate confirmed that the IRS is not seeking out taxpayer with virtual currency with no taxable income – only those with taxable income from the disposal or exchange of virtual currencies.[3]
Why is the IRS concerned?
- The IRS is looking for unrecognized gains on the disposal of cryptocurrencies which would otherwise result in an income tax liability.
- The US tax treatment of cryptocurrencies is that it is capital property – unless dealing in cryptocurrencies.
FinCEN Form 114 requirements
The Financial Crimes Enforcement Network (FINCEN) regulations for the Report of Foreign Bank and Financial Accounts do not include foreign accounts which hold virtual currency as a type of reportable account.
This is being address as FinCEN plans to change the regulations so that virtual currency falls within the ambit of FBAR reporting[4]. This will be done through the Bank Secrecy Act and is currently underway. FINCEN published a notice of proposed rulemaking with the deadline for comments ending 29 March 2021. This includes a proposal that reporting be implemented for CVC or legal tender digital assets similar to the current recordkeeping and requirements relating to transmittal of funds.
[1] Tax Cheats Costing U.S. $1 Trillion a Year, IRS Estimates – Bloomberg Tax April 14, 2021
[2] Crypto User Appeals Dismissal of Suit Over IRS Records – Bloomberg Tax April 21, 2021
[3] IRS Stance on Crypto Spurs Confusion, Relief in Tax Profession.
[4] FinCEN Notice 2020-2