An article this summer in Tax Notes Today examined the United States government’s ability to tax cryptocurrencies. The article came days before cryptocurrencies saw another bullish run in which the value of a single unit of bitcoin once again passed $10,000. Additionally, the article references the comments of IRS special agent Gary Alford who stated the IRS is ready to enforce the taxation of a U.S. taxpayer’s gains from cryptocurrencies. Special agent Alford argues that the public’s familiarity with cryptocurrencies will make it easier for the IRS to file criminal tax cases against some taxpayers who evade their tax reporting obligations. Given this new warning from Alford, criminal tax attorneys need to be prepared to defend their clients who hold cryptocurrencies.
In Notice 2014-12, the IRS wrote that it considers cryptocurrencies to be property and, as such, the disposition or exchange of cryptocurrencies will be taxable. A clear example of a taxable event is where a bitcoin holder exchanges a single bitcoin (or any fraction thereof) for fiat currency. Fiat currency is understood to be currency backed by a national government, e.g. the Euro or U.S. dollar.
A tricky issue for taxpayers may be determining the adjusted basis of their holdings in a cryptocurrency to determine realized gain. Sometimes a single unit of cryptocurrency may have been involved in multiple exchanges and transactions before the taxpayer finally reports to the IRS he or she holds the cryptocurrency. The taxpayer is placed in the difficult task of proving the correct basis of the cryptocurrency. A taxpayer who provides an inaccurate basis is likely to be subject to penalties in addition to the amount in taxes owed.
Another important issue is whether a tax return preparer must now inquire whether their clients hold cryptocurrencies. If a tax return preparer has reason to believe that a client holds cryptocurrencies, does not inquire, and does not report the gains from those cryptocurrencies, then it is possible that the tax return preparer will be subject to an IRC Section 6694 penalty. Treasury Regulation 1.6694-1 provides that a tax return preparer must make reasonable inquiries where the preparer believes information furnished by the taxpayer is incorrect or incomplete. Under IRC Section 6694, failure to make these reasonable inquiries may result in a penalty in amount equal to the greater of $1,000 or 50 percent of the income derived by the tax return preparer with respect to the return or claim. Consequently, tax return preparers need to be more vigilant in the reporting of a client’s cryptocurrency holdings, or else risk expensive tax penalties.
Taxpayers and tax return preparers concerned about their individual liabilities may to want to consider consulting with a tax attorney.