Tax Law Insights

The IRS issued guidance in 2014, through Notice 2014-21, on how to report income from virtual or “crypto” currency transactions.  The IRS has since developed a “Virtual Currency Compliance” program focusing on U.S. taxpayers who may not be reporting, or correctly reporting, virtual currency transactions.  The IRS has now announced it will be issuing notices to over 10,000 specific U.S. taxpayers warning these recipients that they have been identified as having engaged in virtual currency transactions and their U.S. tax compliance obligations.  There are three (3) target letters that will be issued by the IRS, each with the following features:

Letter 6174.  This is essentially a “soft notice” notifying the recipient of potential reporting failures for virtual currency transactions. From the language of this letter, it appears the IRS may believe that virtual currency reporting failures have occurred, but that the failure may not have been intentional.   by Letter 6174 recipients were not willful acts.  The letter asks the taxpayer to review prior tax returns and remedy any filing and/or tax payment failures (e.g., by filing amended income tax returns).  Letter 6174 does not require a response to the IRS if the taxpayer has complied with Notice 2014-21 .  Recipients who discover a virtual currency-related problem should follow the Letter 6174 remedial steps.  These steps include filing amended returns and where the amended returns are marked as “Letter 6174” responses.  These returns must be filed with the IRS at a designated IRS processing center in Philadelphia.

Letter 6174-A.  This “not-so-soft” notice is similar to Letter 6174 but states the IRS has identified the recipient as having one or more virtual currency accounts and where virtual currency transactions related to the accounts may not have been properly reported.  Unlike Letter 6174, this Letter 6174-A  implies that the recipient knew (or the IRS believes the recipient knew) about his/her virtual currency tax obligations.  Much like Letter 6174, no response is required if the taxpayer has fully complied with the Notice 2014-21 reporting and payment requirements, and, if amended returns are filed in response, the amended returns should be marked and filed with the specified IRS processing center.

Letter 6173.  This “hard” notice flat states the recipient has not properly reported cryptocurrency transactions.  Unlike the other notice letter, this Letter 6173 requires a response by a specific date.  The IRS intends to follow-up on these responses to determine if the taxpayer has complied with their United States tax obligations.  In this way, Letter 6173 resembles an audit notice, or at least notice that an audit will be coming.

Depending on responses submitted by recipients, the IRS may impose civil penalties.   Letter 6173 recipients seem most likely of the three to be penalized.  Why?  Because those letters indicate the IRS has more evidence of ill intent (and potential tax evasion) as compared to Letter 6174 or 6174-A recipients.

The IRS likely obtained its taxpayer identifying information last year from the online wallet Coinbase, and where a federal judge forced Coinbase to turn over its customer data.  The IRS obtained data on over 13,000 Coinbase account holders who may have bought, sold, sent, or received cryptocurrencies worth $20,000 or more between 2013 and 2015.

For tax practitioners, this mass IRS compliance campaign harkens back to 2009 when the IRS successfully went after U.S. taxpayers who not reported Swiss bank account information.  There, IRS threats of civil and criminal penalties caused more than 56,000 Americans to pay over $11 billion in voluntary disclosures.    Many who did not voluntarily come forward, were criminally prosecuted or were assessed substantial civil penalties.

Taxpayers should not disregard these IRS notice letters.  Determining the tax on cryptocurrency transactions can be difficult because these currencies are considered property for tax purposes, not cash.  Whether taxpayers think they accurately reported their virtual currency transactions or not, every letter recipient should review their records and previous tax returns for reporting failures, and should consult with knowledgeable tax counsel because of the civil and potential criminal tax implications.