Are Bitcoin Users Cheating on Taxes? (Or Are They Just Confounded by the Rules?)

Based on an IRS investigation, taxpayers numbering only in the 800’s in each of the years 2013 through 2015 reported a transaction description likely related to Bitcoin on the form used to report capital gains or losses from property transactions. In 2013, the IRS issued guidance to say that virtual currency transactions were property transactions, rather than currency transactions, and followed that up with practical guidance in April 2014 in their Virtual Currency Guidance, Notice 2014-21.

Given that Bitcoin traded from less than $20 to over $1,200 between early 2013 to April 2017, and was at less than half of the early April 2017 value in August 2016, significant gains or losses would be expected for many transactions denominated in Bitcoin. The IRS estimates that taxpayers in the tens to hundreds of thousands have transacted in Bitcoin. That means a lot of unreported transactions!

Concerned about the state of affairs of the IRS’ strategy for addressing gains and losses from virtual currency transactions, in late 2016, the U.S. Treasury Inspector General for Tax Administration (TIGTA) released a quite unflattering audit report. The audit report found that no compliance initiatives or guidelines have been developed that would specifically address noncompliance related to virtual currencies, or to assist taxpayers in their voluntary compliance efforts for what records should be kept and how records should be maintained.

In early 2017, as a result of the investigation into compliance that indicates significant numbers of taxpayers are not reporting capital gains and losses in virtual currency transactions, the IRS is seeking a Court order to require Coinbase, the virtual currency exchange, to turn over customer account data, including names and transactions. While Coinbase has yet to comply, claiming the IRS requests are too broad, it is likely that the IRS will ultimately prevail in some form, given precedence in other instances where the IRS succeeded in getting information about taxpayers from a third party participant (for example, Swiss bank accounts from UBS).

Taxpayers who believe they have compliance issues should consider evaluating their situation before the IRS shows up at their doorstep. This virtual currency IRS enforcement focus is likely to be sustained given the potential for fruitful rewards.