Many taxpayers jumped into virtual currency investing during 2017. They might now be asking themselves: Will the IRS know if I made money with Bitcoin (or other virtual currencies)? Do I have to report my gains or losses? Are virtual currency transactions reportable? Yes, Yes and Yes.
Here are what IRS states regarding virtual currency:
- Bitcoins are not a currency. They are considered personal property and taxed as a capital asset.
- If a Bitcoin is converted into currency and there is a gain, it is subject to capital gain.
- If goods or services are purchased with Bitcoins, the taxpayer must also account for the gains.
- A taxpayer that receives Bitcoin as payment for goods or services must include the fair market value of the digital currency received measured in USD in the gross income on the date of the receipt.
- Digital currency that is held and then sold at a gain is subject to either long- or short-term capital gains tax.
- A taxpayer, who holds digital currency for sale in a trade or business, is subject to ordinary gain or loss upon sale.
- Digital currency is recognized income immediately at the fair market value. This income could be subject to self-employment tax
According to the IRS, the general tax principles that apply to “property” transactions are:
- Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
- Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Payers must issue Form 1099.
- The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made with property.
Many Bitcoin investors do not receive appropriate tax advice relating to their virtual currency transactions. Some investors believe that virtual currency transactions are beyond the control and supervision of the government. There are also investors that are under the impression that they can obtain “good advice” on a chatroom or through a web search. Rather, taxpayers investing, making payments or receiving payment in virtual currency ought to consult a credible tax specialist.
For the “virtual currency investor” that thinks that he or she can go “undetected,” on October 2017, the IRS formally launched a new International Tax Enforcement Group dedicated to working significant international tax cases. The group will consolidate under one umbrella, subject experts that have worked cases of international tax compliance. The U.S. Department of Justice Tax Division will provide support to this group. The use of data analytics is critical to the success of the group; which will benefit from information sourced through:
- The Bank Secrecy Act (BSA)
- The Offshore Voluntary Disclosure Program
- The Panama Papers
- IRS “John Doe” summons against Coinbase (a U.S.-based Bitcoin exchange) requiring Coinbase to turn over the tax identifying information of 14,000 accounts
Why Is This Important?
The IRS and the DOJ have accumulated substantial data analytics which they plan to use to increase their focus on virtual currencies. Both the IRS and the DOJ have stated that virtual currency can be a method to evade taxes. From 2013 to 2015, the IRS reported that only approximately 800 to 900 taxpayers reported Bitcoin transactions. This insignificant number of reported Bitcoin transactions indicates significant noncompliance to the government agencies. As a result, the IRS and DOJ will “follow the money” and utilize all of the resources available, particularly in the new International Tax Enforcement Group. Currently there are attachés on the ground in Barbados, Bogota, Frankfurt, The Hague (Europol headquarters), Hong Kong, London, Mexico City, Ottawa, Panama City and Sydney.
Amnesty for Virtual Currency? Not Yet. Best to Come Forward First.
International tax enforcement is a key priority for the United States. The United States has collected a vault of valuable information over the years. Via data analytics, the IRS is going to leverage resources, knowledge and expertise. IRS tax attachés in foreign countries working in tandem with foreign government officials will also assist the IRS.
U.S. taxpayers that have unreported virtual currency transactions as well as unreported assets are advised to come forward first. Out of compliance Taxpayers are ineligible for IRS tax amnesty programs (offshore voluntary disclosure program—OVDP or the streamlined filing compliance procedures—streamlined) if they are identified first.If a taxpayer’s name is identified by FATCA reporting, an “IRS summons” or any other third-party information, the taxpayer will not be able to participate in an OVDP or streamlined program.
Don’t be a victim of your own making. The OVDP and streamlined procedures could be potential options for out of compliance virtual currency taxpayers. Domestic voluntary disclosures could also assist where domestic virtual currency transactions are out of compliance. Consult your tax specialist now.
Stanley Foodman is president and CEO of Foodman CPAs & Advisors in Miami.