There are by some accounts over 4,000 cryptocurrencies in use, Bitcoin being perhaps the best known. There is a huge amount being written about cryptocurrencies and the blockchain technology that enables these digital globs to achieve their goals of absolute security, the capability of nearly instantaneous transactions at very low cost, and transparency within the user group. Cryptocurrency is clearly the new bright shiny object.
However, from a substantive tax point of view, there is very little that is new. The recent Tax Reform Act did eliminate Section 1031 like-kind exchanges for personal property, so if you want to swap your Bitcoin for one or another Altcoin, it will be a taxable transaction: value of what you receive less basis in what you give up.
The fact that there is very little new tax-wise is what is interesting, because as in the heyday of barter transactions, it gives us the opportunity to be reminded of some basic tax rules. A cryptocurrency is just property. Transactions in or using property as currency have tax consequences: you buy Bitcoin, you have a basis in that property; you sell that Bitcoin or use it to purchase other property, you have a capital gain (or loss) equal to the value of the property (or cash) received less the basis of the Bitcoin; you’ve held the Bitcoin for less than a year, a gain is short-term capital gain taxable as ordinary income; you pay a non-employee in Bitcoin in a business setting, you have a 1099 reporting responsibility; you pay an employee in Bitcoin, you have a W-2 reporting and withholding responsibility, and you have to come up with the cash to pay for the withholding and employment taxes (the IRS doesn’t take Bitcoin, yet). The IRS issued a reminder, nothing new, in Notice 2014-21 (Mar. 25, 2014). (Does it startle anyone else that the IRS had issued nearly two notices a week up to that point in 2014?)
So it’s pretty obvious why the IRS would be interested in finding out about transactions in cryptocurrencies. Some of the people interested in secrecy and absolute security are those who might hope that they can treat tax obligations as avoidable nuisances. Or they might just be uninformed or mislead, perhaps willingly, about the tax consequences of these transactions. For these and others involved in or interested in cryptocurrencies, the big news is the IRS’s focus on tax compliance. In News Release IR-2018-71 (March 23, 2018), the IRS warned taxpayers of the dire consequences of compliance failures: audits, penalties, interest, fines, jail. (Does it startle anyone else that the IRS issued nearly six news releases a week up to that point this year?)
Also of significant interest is the IRS case against Coinbase, a digital currency exchange brokering Bitcoin and Altcoin transactions around the world. In a 2016 case filed in Federal court in California, the IRS sought identifying information (including name, address, identification numbers, and birthdates) and transaction records of Coinbase’s customers. Coinbase, joined by many of its customers, some seeking to remain anonymous, resisted. (Wouldn’t you?) In late 2017, the court ordered information to be released for transactions exceeding $20,000 for taxable years 2013 through 2015; in February 2018, Coinbase gave about 13,000 of its customers notice that it would be giving the IRS the information within three weeks. Since it is reported that Coinbase has over 500,000 customers, maybe this is, as Coinbase spins it, a minor victory for the IRS, but if I had dealt with Coinbase in 2016, 2017 or this year, I don’t know on what basis I would be resting easily.
So the IRS can always be counted on to follow the money. And in the spirit of Halloween, if you deal in cryptocurrencies, be vewy, vewy cautious, and a little afwaid.
Written by E. Morgan Maxwell
Since beginning his own firm, Mr. Maxwell has continued a tax-law oriented practice encompassing a wide range of transactions, planning and dispute resolution. His dispute resolution experience includes involvement at all levels of the Internal Revenue Service (Examinations, Appeals, Collections, Office of Professional Responsibility, the U.S. Tax Court), the Pennsylvania Department of Revenue, the Tax Litigation Section of the Pennsylvania Attorney General’s Office, Pennsylvania Commonwealth Court, Common Pleas Court and local taxing jurisdictions in southeastern Pennsylvania.
