Though the regulatory and social climate surrounding bitcoin and similar offerings has often been described as a “Wild West”, there’s no question that governments have been steadily catching up to those they perceive to be in violation of the law when it comes to trading cryptocurrencies.
Identifying cryptocurrency users has continued to be a challenge for these bodies – after all, the entire infrastructure of the emerging space is founded on technology designed to operate independent of the existing financial system. Approaches like the IRS demanding information associated with U.S. citizens from exchanges have been largely successful but are highly inefficient, particularly when users often rely on multiple exchanges dispersed around the globe.
This tax year we saw exchanges issue IRS form 1099-Ks to qualified trades - those with 200 transactions and at least $20,000 in withdrawn currency - but a few weeks ago we saw the first mass campaign from the IRS to individuals in the form of warning letters about possible unpaid taxes. The letters came in three forms: Letter 6173, Letter 6174, and Letter 6174-A. The 6174 versions notify the recipient that the IRS believes taxes or additional taxes may be owed based on their insight into the taxpayer’s activity while letter 6173 makes the claim that taxes are owed. These letters are likely to represent a type of informal safe harbor period where if returns are amended, no further action will be taken so they should not be taken lightly.
With a current market cap of $260b+, it should come as no surprise that the government has ramped up its efforts to hunt (yes, hunt) down tax evaders. The lengths to which the IRS will pursue individuals, however, may surprise even the most paranoid of traders. U.S. cryptocurrency enthusiasts were left in a state of shock in early July, when slides from an IRS presentation on identifying crypto users went viral on Twitter.
According to the IRS presentation, the tax agency is set to roll out an arsenal of, what many would consider, highly-invasive techniques. Using tools to crawl social media for public addresses, chain analysis, and even subpoenas to the App/Play Stores to identify users having downloaded wallet software, it’s clear that the IRS is leaving no stone unturned in their investigations.
This action is driven by a lack of cryptocurrency-related filings over the past years. That said, it may be a disproportionate response to a problem that is aggravated by the government itself: that is, a notable absence of guidance for filing cryptocurrency taxes in the first place. Though the presentation paints a picture of malicious users deliberately shirking their tax responsibilities, the reality is that many will simply be unsure with how to proceed.
At the crux of the issue is regulatory silence: the last piece of IRS guidance issued pertaining to virtual currencies was in 2014. Since then, the technology has evolved and there new questions that were never addressed by the 2014 memo. Crucial questions, such as how to correctly ascertain cost basis, how to properly deal with hard forks, and how to account for (and subsequently calculate) liabilities have yet to be answered. Congress is now ramping up its involvement on behalf of the public - most recently several members penned a letter to the agency demanding answers. In response, the IRS has promised to make the establishment of their revised stance a priority.
The IRS’ new strategy is concerning. While identifying tax evaders is necessary, this sort of strategy is heavy on the punitive side, but alarmingly light on the educational side. Until concise guidance is issued to taxpayers (and, indeed, even after), taxpayers must be proactive in ensuring a meticulous audit trail is maintained, using software to track every transaction made with every specific unit of cryptocurrency. This can become unwieldy for frequent traders or businesses, in which case it’s of paramount importance that they adopt tailored accounting solutions for their crypto activities.