IRS Champing at the “Bit”
The IRS recently announced that it has begun mailing out notices to owners of virtual currency (also referred to as “cryptocurrency”) encouraging them to pay any back taxes and consider filing amended tax returns. These IRS letters alert taxpayers with any virtual currency transactions to file any returns and pay the applicable taxes and penalties. This applies especially to those who potentially failed to report income and pay the corresponding tax connected with these transactions or did not report their transactions properly.
Background on Cryptocurrency
Virtual currencies are often referred to as cybercurrency or cryptocurrency. These were created to take advantage of the unique characteristics of cyberspace. These virtual currencies are similar to cash (paper currency and coins) as no bank account is required; one only needs to possess the virtual currency. The holder can then use this currency to make online purchases. There are over 300 digital currencies available now with “Bitcoin” being the most popular. The uses of the currencies continue to grow, however, this marketplace has been largely unregulated to this point. The use of this virtual currency is less complex than other financial systems, which has led to its growth. Further, most of the activity with virtual currency is done anonymously and is untraceable.
IRS Concerns with Expansion of Cryptocurrency
The growth of virtual currency along with the secrecy it provides and lack of oversight has drawn the attention of the IRS in recent years. The IRS has many concerns with virtual currency. In fact, in 2016 the IRS Inspector General issued a report, As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance, that addressed virtual currency issues.
For instance, a virtual currency could be employed to launder funds from illegal activities and perhaps evade any corresponding tax obligations. In addition, some investors may want to legitimately invest in various virtual currencies, as they would with any other currency, but the IRS wants investors to realize that these virtual currency transactions represent taxable events and come with reporting requirements. The IRS is aware of the risks and issues associated with virtual currency and plans to issue further guidance for taxpayers in the coming months. This should help taxpayers better understand their reporting responsibilities and the tax consequences in dealing with virtual currencies.
Scope of IRS Letter Initiative on Virtual Currency
In conjunction with this upcoming guidance, the IRS launched this letter initiative. They indicated that letters will be sent to over 10,000 taxpayers by the end of August 2019. With these letters, the IRS stated: “the names of these taxpayers were obtained through various ongoing IRS compliance efforts.” The IRS has obtained from some of the virtual currency exchanges the names of parties trading these currencies. In addition, virtual currency has become an ongoing area of emphasis for IRS Criminal Investigation over the past several years. Please click here for a link to this matter from the IRS website.
This IRS is sending out the following three types of letters to owners of virtual currency:
- Letter 6173: this letter requires the taxpayer to provide a reply under “penalty of perjury,” thus caution is warranted in how the taxpayer responds. In addition, this letter calls on the taxpayer receiving the letter to respond by a certain date. The response can be in the form of filing a return to include the virtual currency activity; amending a return to properly report the virtual currency activity; or submitting a detailed statement explaining that the taxpayer has properly reported all transactions and paid all tax related to any virtual currency activity. If no response is received, the taxpayer may be audited.
- Letter 6174: this letter is informational, providing details on what needs to be reported concerning virtual currency transactions, however, this letter does not require the taxpayer to respond.
- Letter 6174-A: this letter is also informational and similar to Letter 6174. It states why the IRS is sending the letter and what the taxpayer needs to do, but it does not require that the taxpayer to respond.
All three of these letters aim to help taxpayers understand their income tax filing and payment obligations, and how to remedy any past filings that may not have been made (or not done properly). Taxpayers may also want to review this matter with their tax counsel prior to responding to the IRS, or amending any tax returns and paying any related tax.
IRS Commissioner’s Comments on this Letter Initiative
Taxpayers should not ignore these letters but need to take this matter very seriously. IRS Commissioner Chuck Rettig stated in this news release issued July 26, 2019: “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties. The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”
Soon after the IRS announced it was sending out these letters, Commissioner Rettig was at a conference and offered this warning:
“If you get a letter, and your name is on the letter, and it’s your home address or the address that matches your tax return, and it’s from the IRS, and it’s encouraging you to maybe take a second look at your return . . . one might assume we had information,” Rettig said dryly.
“We didn’t send a letter to every seventh address. One might assume we had information, and we’re encouraging people to get there first,” he said at the National Association of Enrolled Agents conference in Las Vegas.
There are legitimate and illegitimate uses involved with virtual currencies. With the growth of virtual currencies comes additional scrutiny by the IRS and other taxing authorities. Taxpayers who do not properly report the income tax consequences of virtual currency transactions, however, can be liable for tax, penalties, and interest. In some cases, taxpayers could even be the subject of criminal prosecution. This letter initiative is a key part of the IRS strategy in confronting the virtual currency activity of taxpayers, but this won’t be the last step. The IRS will continue to monitor this area and take the steps it deems necessary. Please contact your Sikich tax professional if you have any questions.