Virtual currency owners experiencing the thrill of record high values should take note that the IRS is stepping up enforcement. Last week, a court ordered Coinbase to disclose information pertaining to more than 14,000 of its customers who have engaged in transactions involving bitcoin, and possibly other virtual currency transactions.
According to its website, Coinbase “is a secure online platform for buying, selling, transferring, and storing digital currency.” Specifically, Coinbase provides users with the ability to create a digital wallet to store digital currency, including bitcoin, Ethereum and litecoin. As further detailed in its website, Coinbase has been used in the exchange of more than $50 billion, supports 32 countries and has served more than 10 million customers.
The court issued its ruling after more than a year of litigation and following the IRS’s decision to significantly narrow the scope of its summons. Originally, the IRS sought information pertaining to any United States person who had conducted a virtual currency transaction at any time during 2013 through 2015. The summons enforced by the court is limited to information regarding accounts “with at least the equivalent of $20,000 in any one transaction (buy, sell, send, or receive) in any one year during the 2013-2015 period.” In opposing the IRS summons, Coinbase disclosed that the records requested by the IRS in the narrowed summons would involve 8.9 million transactions involving these 14,000 customers.
The IRS served its summons because it believes Coinbase’s customers are not complying with Notice 2014-21, which details how “existing tax principles apply to transactions using virtual currency.” In accordance with this notice, the IRS believes virtual currency holdings can be treated as property and that a taxpayer has a gain or loss on a sale or exchange of virtual currency (i.e., every time an individual uses bitcoin or any other virtual currency). In justifying the IRS’s summons, the government disclosed that only 800 to 900 taxpayers a year had reported bitcoin transactions on their tax returns. In enforcing the summons, the court noted that the “discrepancy” between the taxpayers who reported the transactions and the admitted number of transactions “creates an inference that more Coinbase users are trading bitcoin than reporting tagins on their tax returns.” Thus, the court concluded that the government had a “legitimate interest in investigating these taxpayers.”
This interest is further illustrated by the appreciation of bitcoin prices from under $15 in January 2013 to more than $15,000 as of Friday.
Despite the government’s interest in investigating taxpayers who were not reporting their bitcoin or other virtual currency transactions, the court limited the customer information Coinbase was ordered to produce to what it found to be relevant. Specifically, with respect to the covered accounts, the court ordered Coinbase to provide taxpayer ID numbers, names, birth dates, addresses, all periodic statements of account or invoices, along with records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post-transaction balance and the names of counterparties to the transaction.
In ordering Coinbase to produce these categories of documents, the court rejected the government’s broad request for “account opening records, copies of passports or driver’s licenses, all wallet addresses, all public keys for all accounts/wallets/vaults, records of Know-Your-Customer diligence, agreements or instructions granting a third-party access, control, or transaction approval authority, and correspondence between Coinbase and the account holder.” In rejecting the IRS’s request, the court left open the possibility that the government could get this information. The court explained that, if the government later determines it needs any of the excluded records in connection with its investigation of a particular taxpayer, it could issue a new summons to the taxpayer or to Coinbase seeking this information.
Whether or not Coinbase appeals this ruling, taxpayers should consult their tax advisors in determining whether they need to report any virtual currency transactions. Despite well-publicized resource limitations, the IRS is expanding its use of data analytics and demonstrating a commitment to determining whether taxpayers are using digital currency to commit tax avoidance. IRS Criminal Investigation Chief Don Fort recently announced two new programs focusing on data investigations and international tax enforcement (see IRS Criminal Investigation Chief plans new enforcement programs). Taxpayers should determine whether they have unreported taxable digital currency transactions, particularly given the recent and rapid appreciation of bitcoin.
Given the increasing focus of the government on virtual currency transactions, taxpayers who have ever owned virtual currency or digital tokens should consult their tax advisors to determine whether they have any reportable transactions, consider whether they should amend any prior filings that failed to disclose such transactions, and discuss any available disclosure options.
Taxpayers should also consider consulting their tax advisor in calculating any applicable virtual currency transaction tax liability. Such discussions should include, among other things, the taxpayer’s basis, any gains (or losses) the taxpayer may have incurred as a result of any such transaction (regardless of whether the taxpayer received a Form 1099 showing any taxable gain). Even if a taxpayer purchased bitcoin (or another virtual currency) after Dec. 31, 2015, taxpayers should still consult their tax advisor to determine whether they need to report any gains, especially given the rapid appreciation of bitcoin during 2017 and any resulting gains that may have resulted.
Furthermore, any business or third-party organization that currently transacts business using bitcoin or any other virtual currency should consult with a tax advisor to determine any information reporting or other withholding requirements related to these transactions, whether that reporting requirement needs to include the disclosure that the underlying transaction involved a virtual currency, and whether the business or third party is adequately tracking information related to its own virtual currency holdings.
Any possible review should also include situations where a business pays an independent contractor or employee in bitcoin (or other virtual currency) rather than fiat currency, such as U.S. dollars. While it has been more than a year since the IRS agreed it would revise applicable information reporting requirements that could implicate virtual currency transactions, businesses or other third-party organizations should not wait for the IRS to act. Instead, they should examine their own policies, procedures and internal controls to ensure they are complying with existing requirements, make any necessary changes and ensure they are in a position to quickly comply with any newly implemented changes.