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IRS Begins Outreach to Digital Currency Investors

In February 2018, we published general tax guidance as it relates to buying, holding and selling digital currencies, such as Bitcoin and Ethereum. Prior to issuance of the guidance, the IRS had won a major victory against Coinbase to release the identification of digital currency investors.

Armed with that information, the IRS began contacting more than 10,000 taxpayers earlier this month.

What Does the IRS Letter Contain?


There are actually three types of educational letters the IRS is sending out to targeted taxpayers. These letters summarize the Federal tax rules as they relate to virtual currency transactions and filing obligations, but differ in their approach and emphasis:
 
Letters 6174 and 6174-A are referred to "no-action" letters. If the taxpayer has been in full compliance with the tax rules and filing obligations, there is no need to submit a response.
 
Letter 6173, though, infers the taxpayer has been noncompliant for tax years 2013 through 2017, and needs to take corrective action right away. The letter provides a 30-day response deadline, by which time the taxpayer needs to file a delinquent tax return (if no return was filed) or an amended return. Either way, the IRS is expecting taxpayers to fully report their virtual currency transactions.

View or Download IRS Letter 6173

A Brief Review of the Tax Rules for Digital Currencies


Receipt of Digital Currency for Goods and Services
Being paid in the form of a digital currency for rendering a service or providing a product results in ordinary income. The business revenue would typically be based on the value of the coin at the time of the transaction.

Using Digital Currency to Purchase Goods and Services
Since digital currency is treated as property for tax purposes, the capital gain holding periods govern the taxation of any imputed gain or loss. A coin position held for more than a year qualifies for long-term capital gain treatment, while a coin position held a year or less results in short-term capital gain treatment.
 
When the coin position is liquidated to purchase goods and services, the difference between the cost of the coin position and its value at liquidation creates a gain or loss. The holding period between the time the coin position was established and the time of liquidation determines the long-term or short-term nature of the gain or loss.
 
Coin-to-Coin Transfers
Whether or not an exchange of coin (for example, swapping Bitcoin for Ethereum or Litecoin) qualifies as a tax-free like-kind exchange remains a gray area. While the coins are of a similar nature, the other rules for like-kind exchanges (qualified intermediary and direct two-party exchanges) may not be possible in a digital currency environment.
 
Starting in 2018, though, the like-kind issue is moot since the Tax Reform restricts like-kind exchanges to real estate transactions.
 
Coin-to-Currency Transactions
These transactions are very analogous to stock investments. Again, the holding period rules govern the long-term or short-term nature of the gain or loss. Such gains or losses are determined by comparing the original cost of the coin position to the amount of currency (such as US dollars) obtained in a sale or disposition.

What to Do if you Receive IRS Letter 6173, 6174 or 6174-A?

 
Please send us a copy right away. We are not copied on your correspondence from the IRS. 
 
We can assist in determining the extent of any noncompliance, and the related exposure for unpaid taxes, penalties and interest. For relatively small amounts of trading and taxes, filing an amended return during this initial period should be relatively risk-free. For larger amounts, consideration about retaining legal counsel may be appropriate since it does not appear likely the IRS will offer an amnesty period.
 
The last thing to do, however, is ignore the letter. The IRS has warned that taxpayers who do not properly report can be liable for additional penalties, and, in some cases, could be subject to criminal prosecution.
 
Even if you do not receive a letter, and have concerns over the reporting of digital currency transactions in previous tax returns, let's visit and soon!


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