On December 22, 2017, The Tax Cuts and Jobs Act was signed into law. The information in this article predates the tax reform legislation and may not apply to tax returns starting in the 2018 tax year. You may wish to speak to your tax advisor about the latest tax law. This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
- IRS Seeking Virtual Currency Transaction Details
- John Doe Summons
- Background On Bitcoin
- Virtual Currency Tax Reporting Requirements
- Tax Treatment of Virtual Currency Transactions
- Penalties For Failure To Report Virtual Currency Transactions
Apparently, the use of virtual currency in investment and business transactions has reached such proportions as to catch the IRS’s eye. Coinbase, the largest bitcoin exchange firm in the U.S., has been served with an IRS John Doe summons seeking records of all customer transactions with the company from 2013 through 2015. Sources familiar with the case indicate Coinbase will most likely oppose the summons.
With a normal summons, the IRS seeks information about a specific taxpayer whose identity it knows. In contrast, a John Doe summons, the use of which by the IRS is provided for in the Internal Revenue Code and can only be served with a federal court’s approval, allows the IRS to get the names of and requested information and documents concerning all taxpayers in a certain group. It can be a useful tool for the IRS when it is trying to obtain information like a list of investors in a certain tax shelter, owners of tax-exempt bonds, or account holders at a financial institution.
Per the Government Accountability Office, virtual currency is generally considered a digital unit of exchange that is not backed by a government-issued legal tender. The popularity of virtual currencies has grown rapidly in recent years, and there are about 250 active virtual currencies in existence. However, the most popular is Bitcoin, comprising in excess of 80% of the virtual currency market.
Between May 2013 and April 2016, the number of bitcoins in circulation increased from approximately 11.2 million to more than 15.4 million, while the number of daily transactions related to bitcoins has grown from 58,795 to about 220,804. As of December 1, 2016, one bitcoin had the price equivalent of approximately $744, and bitcoins had a total market value of more than $12 billion. The exchange rate for bitcoins to U.S. dollars can be followed on the currency conversion site Oanda.com.
Notice 2014-21, which deals with the tax treatment of virtual currency, provides that virtual currencies are treated as property for tax purposes and that they are subject to the same general tax principles that apply to property transactions. Thus wages paid to employees using virtual currency are taxable to the employee and subject to W-2 reporting and withholding, just like wages paid in dollars.
Independent contractors’ payments in bitcoin are treated the same as self-employment income and included as income on the individual’s business return in the amount subject to self-employment tax. As such, they are also generally subject to SE tax. Businesses making independent contractor payments in bitcoin are subject to Form 1099-MISC reporting rules. In addition, where bitcoin is traded, it is treated as the sale of a capital asset. Failure to report virtual currency transactions can result in substantial penalties in addition to any tax liability.
The following penalties may apply:
- Failure to file information returns: $260 per information return
- Negligence penalty: 20% of the underpaid tax
- Fraud: 75% of the tax due
- Statutory interest on the underpayment
If you have questions related to reporting bitcoin or other virtual currency transactions, please give this office a call.