The IRS, in conjunction with the Department of Justice, is preparing to launch enforcement actions against cryptocurrency-related tax crimes. Earlier this year, the agency said that it will begin to audit taxpayers with crypto assets in both its Small Business/Self-Employed Division and Large Business and International Division. The agency also plans to issue guidance on cryptocurrency to clarify the tax treatment of crypto assets.
Over the next three years, the IRS is expected to increase crypto-related enforcement actions and audit activities to ensure compliance with U.S. tax law. This is partly due to the agency’s concerns that the tax base could be eroded due to increases in cryptocurrency activities. To help prevent tax evasion, the IRS is pursuing enforcement actions for failure to report gains, failure to disclose foreign accounts, and failure to report Initial Currency Offerings (ICO) income.
Failure to report gains
The IRS plans to audit taxpayers who fail to report capital gains incurred through the sale or conversion of cryptocurrency, use of cryptocurrency to purchase goods and services, or receipt of free cryptocurrency through a “fork” or “airdrop.”
Additionally, amounts realized from the sale or exchange of property are subject to tax reporting in the U.S.—a rule crypto traders often ignore. Traders cite the Section 1031 provision, which states that no gain or loss is recognized if property held for investment, or in trade or business, is exchanged entirely for property of like kind. However, as of Jan. 1, 2018, Section 1031 applies only to real estate exchanges and a qualified intermediary is often required to complete exchanges.
Failure to disclose foreign accounts
In 2014, when the IRS said that cryptocurrency was to be considered property for tax purposes, it caused confusion among owners of digital assets as to whether they would be subject to FATCA compliance. It’s likely that ownership of cryptocurrency will be subject to FATCA, since cryptocurrency held in an online wallet is akin to funds held in an online poker account, which also are subject to disclosure requirements. In addition, some taxpayers could be required to file Form 8938 to disclose overseas financial assets.
Failure to report ICO income
Under normal circumstances, the proceeds of a security offering of equity or debt are nontaxable to the offeror. As a result, many ICOs in 2017 and 2018 neither treated the issuance as a realization event nor recognized income from the offering. However, since U.S. securities laws have no impact on tax classification or any other IRS policy, it’s likely that many ICO issuers failed to report income from those offerings, which could lead to enforcement action.
As the rules in this area are set to change within the near future, and enforcement activity could increase, investors holding crypto assets should monitor any changes closely with the help of a qualified tax professional.
