IRS To Cryptocurrency Owners: Come Clean, or Else!
Tax specialists warn those who aren’t in compliance with rules to act quickly to avoid more woes. IRS To Cryptocurrency Owners: Come Clean, or Else!
The Internal Revenue Service is on the war path against Americans who haven’t reported income from cryptocurrencies like bitcoin.
In late July, the IRS said it had started to send warning letters to more than 10,000 people who may not have complied with tax rules on virtual currencies. Agency officials have said criminal tax indictments involving cryptocurrencies are expected soon, and other enforcement letters are going out.
Tax specialists are urging crypto users who aren’t in compliance to act quickly. While coming clean involves a maze of tricky decisions, ignoring the agency could cost a crypto holder dearly.
“I tell them, ‘It’s time to put your running shoes on.’ You must get to the IRS before they find you, especially if you got a letter,” says Bryan Skarlatos, a criminal tax lawyer with Kostelanetz & Fink in New York.
Dealing with the IRS disclosure maze is Mr. Skarlatos’s specialty: He guided nearly 2,000 U.S. taxpayers through it when they confessed secret offshore accounts between 2009 and 2018. He performed triage for more, telling those with cases that wouldn’t land them in prison about simpler solutions.
The IRS’s crypto crackdown has similarities with its offshore-account campaign. Mr. Skarlatos has handled about a dozen high-dollar cryptocurrency cases.
Mr. Skarlatos says people in possible violation of IRS rules should first look for signs of tax fraud. It must involve intentional disobedience of the law. One clear sign is a large amount of unpaid tax, say above $15,000, he adds.
Other signs of fraud can be efforts to disguise cryptocurrency ownership, as by using an assumed name; using a “tumbler” service that mixes some cryptocurrency with others to obscure the original source; and lying to a prior tax preparer—because the IRS will ask.
If there was fraud, the crypto owner will need a lawyer to provide attorney-client privilege. The owner should probably apply to the IRS’s Voluntary Disclosure program, which often levies large civil penalties but protects against criminal prosecution.
If the wrongdoing wasn’t fraudulent, the crypto owner can often file what is called a qualified amended return, typically through an accountant. This will avoid some penalties but not interest.
There is an important exception for crypto owners who weren’t fraudulent but are already known to the IRS. This category includes people who were outed when a federal court required Coinbase, the leading cryptocurrency exchange, to turn over information on about 14,000 customers to the agency.
When the IRS contacts wrongdoers about an audit before they come forward, Mr. Skarlatos says, they often face larger penalties than wrongdoers who weren’t known to the IRS.
The IRS is focusing on cryptocurrencies because their use is expanding, and enthusiasts often praise the anonymity virtual currencies offer. Many trades aren’t reportable to the IRS by third parties—unlike sales of securities such as stock shares, which generally must be reported to the IRS by brokerage firms.
An IRS analysis found that for 2013, 2014, and 2015, when more than 80% of returns were electronically filed, fewer than 1,000 e-filed returns each year reported transactions appearing to use virtual currencies. Coinbase said at the end of 2013 that it had 650,000 accounts. Now it has more than 30 million.
Cryptocurrency advocates are upset by the IRS’s campaign. They say the agency hasn’t yet released long-promised guidance, including how to pinpoint some fair market values; which cost-allocation methods to use; or whether the agency favors a small exemption for personal use. Recently, 60% of global bitcoin transactions were below $600, according to Coin Metrics, a cryptocurrency data provider.
“The scary IRS letters tell people to ‘accurately’ or ‘properly’ report their transactions, but what’s that? Maybe they would have filed if they had clear answers and hadn’t felt overwhelmed,” says James Foust, senior research fellow with Coin Center, an advocacy group.
Advocates also point out that tax reporting is onerous because the IRS classifies cryptocurrencies as property akin to stocks or a home. If someone uses bitcoin to buy a car or lunch, that is typically a taxable sale—as it would be if the person paid in shares of stock.
If the selling price of the bitcoin is higher than its purchase price, then the profit is typically taxable at capital-gains rates. If the selling price is lower, there may be a deductible capital loss. Frequent traders can have thousands of transactions to detail on IRS Form 8949, and cryptocurrencies’ volatility can yield both gains and losses within a short period.
The IRS will dismiss these arguments, says Jordan Bass, a certified public accountant in Los Angeles who says three-quarters of his tax-prep practice involves cryptocurrencies, a specialty he turned to after advising friends with bitcoin.
“The tax framework has been clear since 2014,” he says. “The IRS isn’t going to impose terrible penalties on good-faith efforts, but it will try to make an example of bad actors.”
IRS Sends New Round of Letters To Bitcoin And Crypto Holders
Last week, the United States Internal Revenue Service sent another round of letters to crypto traders called CP2000. These notices were sent to traders of some crypto exchanges due to inconsistencies found in their tax reports.
Using the information provided by third-party systems — such as crypto exchanges and payment systems — the IRS has been able to determine the amounts traders owe and included the amounts in dollars in the notices. Individuals who have received these notices are required to pay within 30 days, starting on the delivery date indicated in the letter.
If you think the exchange — on which you traded — provided your details to the bureau, you are probably right, but do not hold it against the exchanges. The regulation stipulates that all broker and barter exchange services are required by law to annually report trader activity on a 1099-B form, send it directly to the IRS and send a copy to the recipient.
In addition, transaction payment cards and third-party network transactions are also required to report on Form 1099-K, send it directly to the IRS and send a copy to the payee.
The IRS has not yet published specific guidelines for crypto exchanges. In fiat stocks, every broker must submit 1099-B to the IRS and send a copy to the trader. In crypto, the IRS still didn’t publish clarification whether exchanges should provide 1099-K or 1099-B.
Exchanges can benefit from the uncertain situation to provide 1099-K — like Coinbase Pro and Gemini — but some do not provide any forms, such as Kraken and Bittrex. Meanwhile, the exchange must provide the users with the 1099-K copy by the end of every January, so they will be available to use it in their capital gains report. The users, at the same time, don’t submit the IRS their copy of 1099-K, as they only use this form to calculate and report on their capital gains or loss report.
Similarly, earlier this month, the United Kingdom’s tax, payments and customs authority, Her Majesty’s Revenue and Customs, has reportedly requested that digital currency exchanges provide it with information about traders’ names and transactions, aiming to identify cases of tax evasion.
In the U.S., data gathered from these exchanges is collected by the IRS and compared to every trader’s 1099-K report. If the reports do not match the data provided by the exchanges, the IRS will send the CP2000 notice to traders. The notice includes the amount every trader is expected to pay within 30 calendar days.
What’s more, the notice generally includes interest accrued, which is calculated from the due date of the return to 30 days from the date on the notice. This Interest continues to mount until the amount is paid in full, or the IRS agrees to an alternate amount. It means that interest began on the due date — on the day that you were supposed to report this for the first time. If you should, for example, have included this capital gains on your 2017 report, the interest will start on April 2018 — the last day you should have reported this gain. And it’s calculated until the reply date on the CP2000 notice.
Those Who Received The CP2000 Letter Have Two Options:
If The Amount Proposed Is Correct:
Complete the response form, sign it and mail it to the IRS along with the tax payment.
If the amount proposed is incorrect:
Complete the response form and return it to the IRS along with a signed statement outlining why you are in disagreement with the amount listed. It is important to include any supporting documentation to your claims.
It is highly recommended to provide a supporting calculation that is comprehensive and includes all wallet activities and transactions carried out on all exchanges in order to have a complete and accurate report as required by the IRS.
You do not need to file an amended return Form 1040X, but if you choose to do so, you should write “CP2000” on top of it.
It is important to understand that 1099-K reports for individuals trading crypto can be inaccurate in some cases, and does not include the cost basis, which is crucial for crypto trading calculations.
1099-K only asks for the gross amount of the activity. In crypto reports, you need to know how much it costs you (how much you paid when you bought it) and not only how much you got when you exchanged it.
You pay capital gains tax on the profit between the buy amount to the exchange (to fiat or another crypto) amount.
The price you pay for it is called “cost basis.” Without it you will not have an accurate report on crypto. 1099-K forms don’t ask this information, only 1099-b forms do.
Therefore, crypto activity must be fully calculated and compared to the previous tax filing before replying to the IRS notice.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Or Lokay Cohen is the vice president at Bittax, a crypto tax calculation platform. Or has 10 years’ experience with regulation and managing a leading tax consultant firm. She holds an LL.M. law degree, a B.A. in communications and an M.A. in management and public policy. In her work at Bittax, Or promotes the goal of bridging cryptocurrency to the taxation reality to enable tax reporting under a clear regulatory framework and specific identification methods.
IRS Expands Penalties: Which Tax Mistakes Are Better Not To Commit
Willful and non-willful tax flubs are different. Taxes are complex, and innocent tax mistakes can often be forgiven — maybe with no penalty. Even if there is a penalty, non-willful is vastly lower than willful. In a criminal tax case, this fundamental dichotomy can mean the difference between innocence or guilt, freedom or incarceration. But penalties in civil cases can be plenty bad — and most tax cases are civil — and to the United States Internal Revenue Service, bad intent may not be bad at all.
With crypto, the IRS has said it is digging hard, investigating both tax evasion and just poor compliance. But any interaction with the IRS can routinely involve some kind of penalty. Sometimes, the IRS uses the threat of penalties to encourage payments. But in other cases, the IRS pursues penalties with a vengeance.
A good example is offshore accounts, which have strong parallels to crypto tax-compliance issues. Both willful and non-willful failures to report offshore accounts can be penalized. Civil penalties for non-willful violations can be $10,000 per account per year. But if the IRS says you were willful, you can pay up to $100,000 or 50% of the amount in the account. This is for civil cases, imposed in the context of regular IRS audits, even through the mail.
If the IRS says you were willful and wants big penalties, you can pay them or push back through the IRS Appeals Division. IRS Appeals is the classic place where the IRS and taxpayers settle disputes. But sometimes, either the IRS or the taxpayer won’t budge. Some courts say willfulness is a resolution to disobey the law, but one that can be inferred by conduct. Watch out for conduct meant to conceal.
However, much less can now be willful. The IRS penalizes for willful blindness and recklessness. The IRS often refers to Section 6672 of the tax code, which involves payroll taxes. Every employer must withhold taxes and promptly send the money to the IRS. If you don’t, Section 6672 permits the government to collect it from officers, directors and even just check-signers — any “responsible” person who willfully fails to pay employment taxes.
Willful mean in this context is very favorable to the government. Taxpayers are readily found to be willful if they merely ought to have known there was a risk withholding taxes were not being paid, and if they were in a position to find out. The IRS usually wins these payroll tax cases, so willful in this context means pretty little.
Aren’t foreign bank accounts different? The IRS appears not to think so. In the case Bedrosian v. U.S., Arthur Bedrosian opened two Swiss bank accounts in the 1970s but did not tell his accountant until the 1990s. The accountant advised him to do nothing. He said it would be cleared up at Bedrosian’s death, when the assets in the accounts were repatriated as part of his estate. But in 2007, a new accountant listed one account and not the other.
Eventually, Bedrosian amended his tax returns to correctly report both accounts. The IRS said the violation was willful and slapped on a penalty of $975,789 — 50% of the maximum value of the account. The District Court for the Eastern District of Pennsylvania found Bedrosian’s actions “were at most negligent,” and that the omission of the large account was “unintentional oversight or a negligent act.” So, the government appealed to the 3rd U.S. Circuit Court of Appeals.
The 3rd Circuit reversed the lower court’s decision due to the IRS’ arguments about the much harsher willful standards from Section 6672 payroll tax cases.
The 3rd Circuit cited two Section 6672 cases and quoted the standard for reckless disregard from one. The Bedrosian case was remanded to the District Court to apply the new standard. The fear is that willfulness is beginning to look quite broad — just as the IRS likes.
The IRS can almost always show willfulness any time payroll taxes were not paid. The flimsy “in a position to find out” standard in the context of Section 6672 noncompliance is very broad. In short, is the government seeking a sort of carte blanche when it comes to proving willful FBAR penalties (i.e., when one fails to report a foreign bank account)? The Justice Department’s reply in the Bedrosian case claims that the taxpayer, by signing and filing his or her return without reviewing it, “ought to have known” that there was a “grave risk” the form might not be accurate.
This argument suggests an attempt to use the signing of a return as inherent reckless disregard of the duty to report foreign accounts. The Justice Department has successfully argued in other cases that merely signing a return without the proper box checked is per-se willfulness — see United States v. Horowitz, et al., 123 AFTR 2d 2019-500 (DC MD); Kimble v. United States, 122 AFTR 2d 2018-7109 (Ct. Fed. Cl.). The courts in both cases said taxpayers have constructive knowledge of the content of their tax returns and cannot claim ignorance. In Horowitz, the taxpayers are arguing on appeal that the Section 6672 standard is inappropriate because FBAR willfulness occurs in a much different context.
It may be too soon to tell how all of this will shake out. Perhaps many taxpayers facing willful penalties may end up with understanding IRS agents who opt for non-willful penalties, at least if the taxpayer’s explanation and behavior seem reasonable. Taxpayers should be prepared to justify their mistake or misunderstanding in their particular circumstances if they hope to avoid the ever-expanding net of willfulness that seems to be brewing from the government.
There are growing concerns about whether IRS penalties are getting harsher and harsher. So far, the specific context for this drive seems to be in the offshore account arena. That is an easy one for the government.
These days, the IRS has mountains of information and documentation about offshore accounts nearly everywhere. That makes any infractions, however minor, perhaps even more risky than most other tax gaffes.
Still, if the IRS’ drive for penalties continues, one wonders if we might one day have strict liability for tax problems. In the meantime, when it comes to penalty notices and disputing penalty findings at any level, extra care is likely to be required.
The IRS Is Blindly Coming After Cryptocurrency Traders — Here’s Why
Over the past month, we have seen the IRS, the tax collecting agency of the United States, send out more than 10,000 warning and action letters to suspected cryptocurrency holders and traders who may have misreported digital assets on their tax returns. Letters like the 6174-A, 6173 and CP2000 have appeared in the mailboxes of cryptocurrency traders throughout the country, and the crypto tax software company that I run has seen an influx of frantic customers coming to us for tax help out of fear of penalties.
The problem here is that the IRS doesn’t have all of the necessary information. In fact, not only does it not have all the information, but the information that it does have on the cryptocurrency holders that it is sending letters to is extremely misleading. This information, which was supplied to the IRS by cryptocurrency exchanges like Coinbase, is causing the agency to blindly and oftentimes inaccurately come after cryptocurrency traders.
Related: Internal Revenue Service Sends New Round of Letters to Crypto Holders
Allow me to break this down further.
How Is Cryptocurrency Taxed In The U.S.?
In many countries around the world — the U.S. included — cryptocurrencies like Bitcoin are treated as property from a tax perspective, rather than as a currency. Just like other forms of property — stocks, bonds, real-estate — you incur capital gains and capital losses that need to be reported on your tax return whenever you sell, trade or otherwise dispose of your cryptocurrency.
Pretty straightforward: If you make a bunch of money investing in Bitcoin (BTC), you have a capital gain and a tax liability that needs to be reported. If you lose a bunch of money, you have a capital loss, which will actually save you money on your tax bill — though it still needs to be reported.
It doesn’t come as a huge surprise that many enthusiasts have not been paying taxes on their cryptocurrency activity. Because of this, it actually makes a lot of sense why the IRS has started carrying out these enforcement campaigns. However, the agency is using information that is extremely misleading, and it is leading to problems. This misleading information starts with Form 1099-K.
Breaking Down Form 1099-K
Cryptocurrency exchanges like Coinbase, Gemini and others issue 1099-K’s to users who meet certain thresholds of transaction volume on their platforms. The IRS states on its website that the 1099-K is an information return used to report third-party network transactions to improve voluntary tax compliance.
In plain English, the 1099-K is used to report your gross transactions on a third-party network — in this case, a cryptocurrency exchange. This means that all of your transactions, buys, sells, transfers, etc. are summed up and reported on a 1099-K. If you meet certain thresholds — gross payments that exceed $20,000 and more than 200 such transactions — you and the IRS are both sent a copy of this 1099-K from the cryptocurrency exchange. The IRS is using these documents to monitor who is and isn’t paying taxes correctly.
These “gross transaction” reports can quickly get extremely large for high volume cryptocurrency traders. Remember, every transaction you made is being summed together on this form. I purchased $1,000 worth of Bitcoin, and then traded that Bitcoin in and out for Ether (ETH) five times, and my gross proceeds are now over $6,000 — even though I only ever “put in” $1,000 cash! This is because all “buy” transactions are added together to report gross proceeds, and in this case, I technically had six different buy transactions and six different “sell” transactions — a Bitcoin trade into ETH is considered both a buy of ETH and a sell of BTC.
You can see how this number can become extremely large for a high volume trader. At CryptoTrader.Tax, we’ve seen 1099-K’s from customers in the millions of dollars range when the trader only ever had a few thousand dollars worth of crypto.
Why this is so problematic
1099-K’s are reporting gross transaction amounts and are being sent to the government. Yet, the numbers reported are completely irrelevant when it comes to tax reporting, as you are only actually taxed on your capital gains and losses.
Again as an example, say you purchased $10,000 worth of Bitcoin in April and then sold it two months later for $9,500. You have a $500 capital loss that would be deducted from your taxable income. However, reported on 1099-K, nothing is said of your net loss; the form only tells the government that you have $19,500 of gross cryptocurrency transactions.
Ultimately, 1099-K is not a form that should be used for tax reporting purposes, yet the IRS is relying on it for enforcement. Many people often mistake the 1099-K that they receive from cryptocurrency exchanges with the typical 1099-B that they might receive from their stock broker or other investment platform outside of crypto. The 1099-B is the correct form that reports all necessary information required to calculate and accurately report capital gains and losses — including cost basis and fair market value of your investments. It’s very easy to determine your total capital gain and loss with this form, contrary to 1099-K.
The fact that the IRS is relying on 1099-K to issue action letters is problematic.
Unfortunately, cryptocurrency exchanges do not have the ability to give you an accurate Form 1099-B.Why cryptocurrency exchanges can’t provide tax reports like a stock brokerage does because cryptocurrency users are constantly transferring crypto into and out of their exchanges, the exchange itself has no way of knowing how, when, where or at what cost (cost basis) you originally acquired your cryptocurrencies. It only sees that they appear in your wallet on their platform.
The second you transfer crypto into or out of an exchange, that exchange loses the ability to give you an accurate report detailing the cost basis and fair market value of your cryptocurrencies, both of which are mandatory components for tax reporting. In other words, cryptocurrency exchanges do not have the ability to provide you with the necessary information to calculate your capital gains and losses. This also means that they also don’t have the ability to provide you with a 1099-B.
Coinbase Itself Explains To Its Users In Its Faqs That Their Generated Tax Reports Won’t Be Accurate If Any Of The Following Scenarios Took Place:
You Bought Or Sold Digital Assets On Another Exchange.
You Sent Or Received Digital Assets From A Non-Coinbase Wallet.
You Sent Or Received Digital Assets From Another Exchange, Including Coinbase Pro.
You Stored Digital Assets On An External Storage Device.
You Participated In An Initial Coin Offering.
You Previously Used A Method Other Than ”First In, First Out“ To Determine Your Gains/Losses On Digital Asset Investments
These Scenarios Affect Millions Of Users.
The information that the IRS is receiving from cryptocurrency exchanges does not reflect your capital gains and losses whatsoever. This is problematic because these capital gains and losses are what you actually pay taxes on, not gross transaction amounts.
So, if you received a warning letter from the IRS, don’t panic. As long as you have been properly filing your cryptocurrency gains and losses on your taxes, you should be fine. The absurdly high numbers that you are seeing on these letters are often times irrelevant.
Nonetheless, it is a good idea to consult a tax professional who is familiar with cryptocurrency for further help and clarification — especially if it’s an action letter.