Lahti, Lahti & O'Neill, P.C. Blog

Monday, November 28, 2016

Virtual Currency Creates Real Tax Concerns

By Michael T. Lahti

If you are a user of “virtual” currency such as Bitcoin, be careful.  The IRS recently issued a summons to Coinbase (a major player in the virtual currently world), and is looking for people who use Bitcoin to evade taxes.  The summons requested records of all customers who bought virtual currency from the company, from 2013 to 2015.  The IRS thinks, probably correctly, that many people are using the virtual currency to avoid taxes.

The summons follows the Treasury Department’s report that criticized the IRS for not aggressively pursuing “unlawful activities by those who use virtual currencies.”  The Summons would require Coinbase to turn over information for millions of customers, and the company is indicating it will fight the request.  “We want to work with law enforcement — that’s generally our policy,” the company’s head legal counsel, Juan Suarez, said Friday. “But we can’t tolerate sweeping fishing expeditions. We are very concerned about the financial privacy rights of our customers.”

Coinbase buys and sells “Bitcoins,” and records the identities of people who buy and sell virtual currency.  The underlying Bitcoin wallets, however, are tracked by a decentralized network of computers that generally do not record the identities of the people involved in transactions. A Bitcoin wallet looks like a series of random letters and numbers, and anyone can open one without providing their identity.

The documents filed this week indicated that the tax agency was interested in going after both large tax evaders, as well as small-time Bitcoin users who might not be recording their virtual currency transactions properly for tax purposes.

The basic tax rules for Bitcoin users were set down by the IRS in 2014. IRS said that people should treat their virtual currency as property, rather than currency, for tax purposes. For example, if a person buys a Bitcoin for $200, then sells it later when its value has risen to $400, the $200 in gains are supposed to be recorded to the tax authorities.

Coinbase provides its customers with information about the gains or losses they make on every virtual currency transaction. But the IRS said it was not getting the information it needed to determine whether Coinbase users were making the proper tax payments.  “The risk/reward ratio for a taxpayer in the virtual currency environment is extremely low, and the likelihood of underreporting is significant,” an official at the IRS recently commented. “The characteristics of virtual currencies could enable them to replace traditional abusive tax arrangements as the preferred method for tax evaders.”

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