On November 30, 2016, Judge Jacqueline Scott Corley of the U.S. District Court for the Northern District of California signed an order granting the request of the Internal Revenue Service (IRS) to serve a summons on a virtual currency exchanger for the names of its bitcoin account holders and their associated transaction records, account statements, and records of payments made and processed for these users, all for the period January 1, 2013 through December 31, 2015. The IRS was concerned that account holders who were U.S. taxpayers were not properly reporting their virtual currency transactions as required. Because bitcoin transactions are pseudonymous, the IRS did not know the names of the relevant individual accountholders and so asked the court for permission to instead serve the summons on the virtual currency exchanger.
IRS and Virtual Currency – Brief Background
On March 25, 2014, the IRS issued Notice 2014-21, stating that virtual currency was to be treated as property, rather than currency. The IRS also stated that taxpayers must “in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date the virtual currency was received.” Taxpayers may have a gain or loss upon exchange of virtual currency, the character of which will generally depend on “whether the virtual currency is a capital asset in the hands of the taxpayer.” The notice permitted the public to submit comments.
Two and a half years later, in September of 2016, the Treasury Inspector General for Tax Administration (TIGTA) issued a report on the use of virtual currencies in taxable transactions, finding that additional actions are needed to ensure taxpayer compliance. TIGTA had three recommendations for the IRS:
- 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
- Provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies
- Revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.
The IRS generally agreed with the recommendations, within the scope of its available resources and other competing organizational and legislative priorities.
The November 2016 Summons Request
According to the IRS memorandum filed with the court, the perceived anonymity of bitcoin transactions and the lack of third-party reporting has caused the IRS to be concerned that virtual currency transactions are being underreported, which likely has resulted in U.S. taxpayers failing to report taxable gain on virtual currency transactions. An accompanying declaration from an IRS agent noted that there were:
[F] actors indicating the likely incidence of tax delinquency involving virtual currency, including a lack of third-party information reporting [on virtual currency transactions]; relative anonymity of the transactions; a public perception that tax evasion is possible with virtual currency; and a failure among virtual currency users to afford virtual currency transactions the proper tax treatment, including the proper valuation of such transactions.
The IRS memorandum did not describe the types of reportable transactions it was seeking with the summons, but the underlying agent declaration described virtual currency transactions that the agent states are required to be reported:
- Wage, salary, or other income paid to an employee with virtual currency is reportable by the employee as ordinary income and subject to employment taxes paid by the employer.
- Virtual currency received by a self-employed individual in exchange for goods or services is reportable as ordinary income and is subject to self-employment tax. This would include a person who “mines” virtual currency as a trade or business.
- Virtual currency received in exchange for goods or services by a business is reportable as ordinary income.
- Gain on the exchange of virtual currency for other property is generally reportable as a capital gain if the virtual currency was held as a capital asset and as ordinary income if it is property held for sale to customers in a trade or business.
- Gain on the sale of property held as a capital asset in exchange for virtual currency is reportable as a capital gain.
- 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.
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