Wealthy clients with bitcoin or other virtual currencies should know that the IRS is expecting better reporting of these investments.
The IRS requires taxpayers to track crypto transactions to prove how much they bought, so they can determine how much they owe when they sell. The agency has also released guidance to tell virtual-currency investors how they’re expected to report income, applying such longstanding tax rules as short-term capital gains for assets held for less than a year. Investors also must document transfers of coins between two accounts (aka wallets).
“Cryptocurrency is treated as property, an asset,” said Suzanne Shier, Chicago-based wealth-planning practice executive and chief tax strategist for Northern Trust Wealth Management. “This distinction … means that transactions with cryptocurrency are treated as sales or exchanges for income tax purposes and must be reported as such. Taxpayers need to keep record of purchases and exchanges, with basis and fair market value, just like other assets.”
(“Virtual currency” is a digital representation of value that functions as a medium of exchange other than a representation of the United States dollar or a foreign currency. “Cryptocurrency” is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distribution ledger.)
“I don’t think it’s fair to say that investors have had to largely guess how to report income and pay taxes from virtual currency,” said Sarah Paul, partner at Eversheds Sutherland in New York and in the firm’s litigation, federal tax controversy and criminal tax groups. “The guidance the IRS issued five years ago did provide that for purposes of federal income tax, virtual currencies should be treated as property.
“The biggest misconception out there, in my view, is the idea that the IRS is behind the curve with cryptocurrency enforcement and that non-compliance is an option,” Paul said.
Cryptocurrency transactions have likely been seriously underreported for years: In a 2017 affidavit filed by the IRS in its subpoena of bitcoin broker Coinbase, the agency stated that fewer than 1,000 taxpayers filed returns for 2013 to 2015 that accounted for cryptocurrency holdings, “in contrast to the millions of Coinbase wallet holders,” said Kristen Garry, partner in the tax practice and head of the Washington, D.C., office of Shearman & Sterling.
The IRS will focus next on rules for gross proceeds reporting of cryptocurrency transactions, similar to the information reporting that occurs in securities transactions, she added.
The IRS did recently send letters to some 10,000 taxpayers regarding cryptocurrency transactions; some taxpayers also received notices claiming that they’d underpaid tax on transactions.
Other cryptocurrency IRS documents, according to Mark DiMichael, CPA and partner, valuation and forensic services, at Citrin Cooperman in New York, include the CP2000, which the IRS sends when its information doesn’t match the information that a taxpayer reported. Other recent IRS correspondence takes holders of cryptocurrency through levels of the agency’s suspicions about their reported income.