The honeymoon period for bitcoin is over. Not waiting for Congress to figure out what to do about virtual currency and how to regulate it, the Internal Revenue Service has fired the first shot across the bow of Coinbase, one of the world’s largest bitcoin trading exchanges, by serving Coinbase with a John Doe summons seeking customer information. Coinbase challenged the summons, but a federal court in San Francisco has ordered Coinbase to turn over information sought by the IRS regarding its bitcoin customers. See United States v. Coinbase, 2017 WL 5890053, Case No.17 cv 01431 (N.D. Calif. Nov. 29, 2017). The federal court order requires Coinbase to divulge details on all bitcoin customers who made a transaction worth $20,000 or more between 2013 and 2015. Coinbase has estimated that this request would total over 8.9 million transactions between 14,355 different account holders, according to the court order. To understand the significance of the IRS’s action against Coinbase, we must turn back the clock to 2014.
In 2014 the IRS issued Notice 2014-21 (2014-16 I.R.B. 938), which describes how the IRS applies U.S. tax principles to transactions involving virtual currency. According to the IRS, virtual currencies that can be converted into traditional currency are considered “property” for tax purposes, and a taxpayer can have a gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer’s cost to purchase the virtual currency (i.e., tax basis). Thus, under general tax principles applicable to property transactions, virtual currency transactions are reportable to the IRS in the following situations:
• Wage, salary, or other income paid to an employee with virtual currency is reportable by the employee as ordinary income, subject to employment taxes.
• Virtual currency received by a self-employed individual in exchange for goods or services is ordinary income subject to self-employment tax.
• Virtual currency received in exchange for goods or services by a business is reportable as ordinary income.
• Gain on the sale of property held as a capital asset in exchange for virtual currency is reportable as a capital gain.
• Gain on the exchange of virtual currency for other property is generally reported as a capital gain if held as a capital asset and as ordinary income if it is property held for sale to customers in a trade or business.
• Payments made in virtual currency are subject to information reporting requirements to the same extent as payments made in real currency or instruments denominated in real currency.
