The Internal Revenue Service needs to do more to ensure taxpayers aren’t using virtual currencies like bitcoin to avoid taxes, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, pointed out that digital currencies have grown in popularity in recent years as an alternative to traditional currency like the U.S. dollar. However, some virtual currencies, such as bitcoin, are popular in part because the identities of the parties involved in a transaction are typically anonymous, which could lead to potentially illegal activity.

In 2014, the IRS issued Notice 2014-21, Virtual Currency Guidance, and set up a Virtual Currency Issue Team, but since then, the report found little evidence of coordination between the responsible functions at the agency to identify and address potential taxpayer noncompliance issues for digital currency transactions.

The IRS asked for comments on Notice 2014-21 from the public two years ago but didn’t take any actions to address the comments it received. TIGTA reviewed all the comments and found several examples of information requested by the public that would be helpful in understanding how to comply with the IRS’s tax reporting requirements when using or receiving virtual currencies.

None of the IRS’s operating divisions have developed any compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance pertaining to virtual currencies.

The IRS has also not used an important enforcement tool at its disposal to address unlawful activities by those who use virtual currencies. Under the authority of the Treasury Department Financial Crimes Enforcement Network, also known as FinCEN, the IRS has Bank Secrecy Act enforcement responsibilities for financial institutions that are not regulated by a federal bank agency or another federal regulator such as money service businesses. While FinCEN has designated administrators or exchanges that can accept and transmit a virtual currency, or buy or sell virtual currency as money service businesses that are subject to IRS enforcement, the IRS has not taken enforcement action in this area, the report noted. The actions already taken by the IRS to address virtual currency tax noncompliance do not appear to have been coordinated to ensure a strategic approach.

Third-party methods of reporting taxable transactions to the IRS do not separately identify transactions related to virtual currencies.  While employers and businesses are required to report taxable virtual currency transactions, current third-party information reporting documents do not provide the IRS with any means to identify that the taxable transaction amounts being reported were specifically related to virtual currencies.

“It is imperative that the IRS ensures that those who engage in activities using virtual currencies comply with all of their tax obligations,” said TIGTA Inspector General J. Russell George in a statement.

TIGTA made three recommendations in the report. The IRS agreed with them and plans to develop a virtual currency strategy, including an assessment of whether changes to information reporting documents are warranted. The IRS also agreed with TIGTA that more guidance would be helpful. It plans to share the recommendation with the IRS’s Office of Chief Counsel for coordination with the Treasury Department’s Office of Tax Policy.

In response to the report, the IRS pointed out that it has done some preliminary compliance work related to virtual currencies, including several criminal investigations that have successfully disrupted criminal enterprises using the currencies for illegal transactions. “We have also issued guidance to taxpayers on virtual currencies, in addition to developing and delivering training to our employees on this emerging issue,” wrote Douglas W. O’Donnell, commissioner of the IRS’s Large Business and International Division. “But we agree that more can be done to develop a coordinate virtual currency strategy, and we will work on further developing the IRS’ overall strategic approach to virtual currencies, taking into account the findings in your report.”

In the report, TIGTA noted that the IRS’s 2014 guidance specifies that the same general tax principles that apply to property transactions also apply to transactions using virtual currencies. For example, that means the fair market value of virtual currency paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act tax, and Federal Unemployment Tax Act tax and should be reported on Form W-2, Wage and Tax Statement. Payments using a virtual currency made to independent contractors are taxable, and self-employment tax rules apply. Generally, payers must issue a Form 1099-MISC, Miscellaneous Income, to the IRS and to the payee. The character of gain or loss from the sale or exchange of a virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A payment made using a virtual currency is subject to information reporting to the same extent as any other payment made in property.

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