The IRS’s indifferent approach to virtual currency appears to be coming to an end. After a Treasury Inspector General’s report in September 2016 criticized the agency for doing nothing to ensure taxpayer compliance in virtual currency transactions, the IRS jumped to attention and petitioned a court in California seeking to obtain over 1 million customer records from Coinbase, Inc., a virtual currency exchanger headquartered in San Francisco, California.
The federal District Court for the Northern District of California granted the IRS’s request for a “John Doe” summons in late November. This type of summons allows the IRS to get the names, information, and documents concerning all taxpayers in a certain group instead of having to name specific taxpayers under investigation. The IRS wants the records of Americans who conducted transactions in virtual currency through Coinbase from the years 2013-2015. There is no allegation in the suit that Coinbase has engaged in any wrongdoing in connection with its virtual currency exchange business. The IRS just wants to get to its customers.
Money is Money
“Tools like the John Doe summons authorized today send the clear message to U.S. taxpayers that whatever form of currency they use – Bitcoin or traditional dollars and cents – we will work to ensure that they are fully reporting their income and paying their fair share of taxes,” said Caroline D. Ciraolo, head of the Justice Department’s Tax Division in a news release. There are nearly a thousand virtual currencies with such fanciful names as Litecoin, Darkcoin, Peercoin, and Dogecoin, but the most widely known and largest is Bitcoin, according to the Justice Department. Because of the nature of virtual currency, transactions can be difficult to trace, the Justice Department argued before the Court. In the court’s order, U.S. Magistrate Judge Jacqueline Scott Corley found that there is a reasonable basis for believing that virtual currency users may have failed to comply with federal tax laws.
What are Bitcoins and Coinbase, Inc.?
“Coinbase is a digital currency wallet and platform where merchants and consumers can transact with new digital currencies like bitcoin and ethereum. We’re based in San Francisco, California.”
“Bitcoin is the world’s most widely used alternative currency with a total market cap of approximately $10 billion. The Bitcoin network is made up of thousands of computers run by individuals all over the world.”
–From the Coinbase website.
Not so Fast, Says Coinbase
After the order was issued, Coinbase quickly filed a motion to intervene and quash the summons, citing the Treasury Inspector General’s criticism of the IRS’s lack of clear guidance on its virtual currency policies. “None of the IRS operating divisions have developed any type of compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currencies,” the Treasury report concludes.
The motion also attacks the summons as being too broad in scope and notes that the IRS will not be able to review the amount of data sought because it
“does not have sufficient funding to pursue enforcement efforts.” The motion goes so far as to accuse the IRS of “bad faith.” Still, the IRS has wide latitude to issue John Doe summonses, and it is unlikely that Coinbase’s challenge will prevail.
IRS Developing Policy
The IRS issued Notice 2014-21 about two years ago explaining that virtual currency is property for tax purposes and will be taxed as capital gains or losses when bought and sold. However, the guidance stopped there. What is the IRS’s next move? The Treasury Inspector General for Tax Administration (TIGTA) has 3 recommendations for the IRS:
1. Develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation;
2. Provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies; and
3. Revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.
The IRS has agreed with these recommendations and plans to develop a policy regarding what kinds of information reporting should be required for virtual currency transactions. We can expect to see the same strategy that has been happening over the last 10 years with the IRS—a reliance on third-party reporting. We now have broker reporting of basis for investments, third-party settlement companies reporting credit card transactions, foreign financial institution reporting on U.S. account holders, and the whole family of Forms 1099. Is Form 1099-VC* next?
What is a Bitcoin Worth?
According to CoinDesk in mid-December 2016, a Bitcoin was worth about $780.