On July 26, 2019, the IRS announced that it had begun sending letters to taxpayers who may have failed to properly report income and pay any tax associated with cryptocurrency (which the IRS calls “virtual currency”) transactions or who did not properly report such transactions. The IRS expects to send more than 10,000 letters before the end of August.
There are three variations of what the IRS is calling “educational letters” — “Letter 6173,” “Letter 6174,” and “Letter 6174-A” — which are designed to assist taxpayers with understanding their tax and reporting obligations and how to address any errors. The letters vary in severity, ranging from a suggestion to confirm whether a reporting error or deficiency exists to an allegation of a reporting omission requiring a response. Which variation of the letter a taxpayer receives will depend on the information the IRS has about the recipient.
Taxpayers who have not properly reported their cryptocurrency transactions are, where appropriate, liable for tax, penalties, and interest, and in certain cases, may be subject to criminal prosecution.
In 2016, the IRS served a “John Doe” summons on Coinbase, one of the most prominent cryptocurrency exchanges, and in February of 2018, pursuant to an order from a federal district court, Coinbase provided the IRS with the taxpayer identification numbers, names, dates of birth, addresses, and transaction information covering 2013 through 2015 for approximately 13,000 of its customers.
The information received from Coinbase may likely form the basis of forthcoming criminal tax cases. Don Fort, the chief of the IRS’s Criminal Investigation Division, recently announced that the IRS is building criminal tax-evasion cases involving cryptocurrency and expects to make them public soon. And, while the IRS declined to comment on whether any of the “educational letters” stem from Coinbase’s response to the summons, it is safe to assume that at least some of them do.
The US Securities and Exchange Commission (“SEC”) published a document indicating plans to run through contractors a Bitcoin and an Ethereum full node and nodes on as many as possible of the following blockchains: Bitcoin Cash, Stellar, Zcash, EOS, NEO, and XRP Ledger. The SEC is seeking the full ledgers since inception (i.e., the genesis block) and all derivative currencies (tokens) for all of those blockchains. Further information is limited at this time, but the SEC stated that the purpose would be “to support its efforts to monitor risk, improve compliance, and inform Commission policy with respect to digital assets.”
This development follows notable activity by the SEC in the cryptocurrency space, including an April 2, 2019 No Action Letter regarding TurnKey Jet, Inc., an April 3, 2019 Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets”, and a July 25, 2019 No Action Letter regarding Pocket Full of Quarters, Inc.
As the US government continues to focus on compliance issues related to cryptocurrencies, it is reasonable to expect that other agencies, including the IRS, will follow the SEC and begin accessing and monitoring entire cryptocurrency blockchain ledgers through a full node. A move like this would make it much easier for the IRS to match cryptocurrency activity with the information reported on an income tax return.