Cryptocurrencies & Taxes: 2019 Year in Review
The IRS is making cryptocurrency reporting a higher priority than in years past. Prior to 2019, the most recent guidance the IRS provided on cryptocurrency reporting was in 2014 via Notice 2014-21. Now, it appears the IRS is upholding its Virtual Currency Compliance campaign announced on July 2, 2018, as the IRS and U.S. Department of the Treasury (Treasury) continue to issue new guidance on virtual currency transactions.
Here are the cryptocurrency tax-related highlights that occurred in 2019:
- The American Institute of CPAs (AICPA) Virtual Currency Task Force received guidance from the Treasury’s Financial Crimes Enforcement Network (FinCEN).
- The IRS sent letters to cryptocurrency users with unreported transactions.
- Revenue Ruling (Rev. Rul.) 2019-24 was released, which includes guidance on the treatment of hard forks.
- The IRS published a webpage solely dedicated to answering frequently asked questions (FAQ) on virtual currency transactions.
- The Schedule 1 of the final 2019 Form 1040 includes a question asking taxpayers if they received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency during the year.
FinCEN Responds That Virtual Currency Isn’t Reportable on Form 114
The AICPA Virtual Currency Task Force was informed by FinCEN that virtual currency isn’t reportable on Form 114. Form 114 generally is used to report money held in offshore bank accounts. FinCEN cited 31 CFR Section 1010.350(c) as not specifically defining virtual currency. However, FinCEN did state that “in consultation with the IRS, [it] continue[s] to evaluate the value of incorporating virtual currency held offshore into the FBAR regulatory reporting requirements.” Cryptocurrency users who use a foreign exchange should keep this guidance and future guidance from FinCEN in mind.
IRS Sending Letters to Crypto Users with Unreported Transactions
The IRS is sending letters 6173, 6174 and 6174-A to notify taxpayers the agency is aware of transactions involving cryptocurrency and other virtual currencies that weren’t correctly reported.
IRS Letter 6174-A begins, “We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.” Letters 6173 and 6174 start with similar language. Consequences of inaccurately reporting cryptocurrency transactions may include civil or criminal enforcement actions.
Letter 6173: 6173 is an action letter, meaning action is required as a result of receiving this letter. Not responding to the letter could result in the IRS referring your tax account for examination.
Letter 6174: 6174 is an educational letter, with the intent of informing taxpayers of their obligations to report virtual currency transactions.
Letter 6174-A: 6174-A also is an educational letter similar to 6174, with one slight change. This letter also includes language that the IRS may send other correspondence in the future about potential enforcement activity.
In November 2017, a federal court ordered Coinbase, Inc., one of the largest U.S. cryptocurrency exchanges by volume, to produce customer information to the IRS, including taxpayer ID number, name, date of birth, address and records of account activity (United States v. Coinbase, Inc., Case No. 17-cv-01431-JSC). Similarly, on July 2, 2018, the IRS announced that virtual currency would be one of the five new large business and international compliance campaigns. On May 16, 2019, IRS Commissioner Charles Rettig issued a letter to Congressional Rep. Tom Emmer indicating the IRS plans on issuing guidance “related to the taxation of virtual currency transactions.” Now, the IRS is sending letters 6174, 6174-A and 6173 to taxpayers urging them to comply with IRS reporting requirements related to cryptocurrency transactions.
The misconception that all cryptocurrencies are anonymous is proving to be untrue. Most cryptocurrencies are pseudo-anonymous. If you transact in cryptocurrencies on the blockchain and your identity is ever linked back to your blockchain address or transactions, then your activity isn’t anonymous. It’s likely the IRS has taken the information from United States v. Coinbase, Inc. to identify taxpayers who believed their transactions were anonymous.
What Should I Do If I Receive Letter 6173, 6174 or 6174-A from the IRS?
If you receive IRS Letter 6173, 6174 or 6174-A or any related letter or notice, contact your BKD Trusted Advisor™. Review your tax returns. If you feel uncomfortable with how you may have reported your cryptocurrency transactions in previous tax years, you may be able to take action before the IRS does. These letters urge taxpayers to take action by filing amended or delinquent tax returns if needed. If no action is taken to respond to the letter, your tax returns may be selected for an IRS audit.
IRS Rev. Rul. 2019-24
In October 2019, the IRS released Rev. Rul. 2019-24, which focuses on the tax treatment of hard forks and airdrops. The ruling states that a taxpayer has an accession to wealth under Internal Revenue Code §61 when, as a result of a hard fork or airdrop, the taxpayer has constructively received the new cryptocurrency. Constructive receipt means the taxpayer has the ability to transfer, sell, exchange or otherwise dispose of the cryptocurrency. In the year of constructive receipt, the taxpayer is to report ordinary income equal to the fair market value of the new cryptocurrency at the date of receipt. Going forward, the amount included in ordinary income in the year of receipt is now included as the taxpayer’s basis in that asset.
IRS FAQs on Virtual Currency Transactions
On the same day the IRS released Rev. Rul. 2019-24, the IRS also published a Virtual Currency FAQs webpage. The webpage currently boasts 45 questions and answers relating to virtual currency, including how to calculate a gain or loss, how to determine basis, when the holding period starts for cryptocurrency received, how to calculate charitable contribution deduction when cryptocurrency is donated and what records need to be maintained for cryptocurrency transactions. Note, while published by the IRS, this webpage isn’t authoritative guidance.
2019 Form 1040
In addition to guidance released in October 2019, the IRS added the following question to Schedule 1 of the 2019 Form 1040. The following question appears on the draft Schedule 1:
At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency? ◊ Yes ◊ No
According to IRS Chief Counsel Michael Desmond, approximately 12 million tax returns should be reporting some type of cryptocurrency transaction, which is nowhere near what the IRS actually sees in practice. This added question on Schedule 1 is to help give the IRS more transparency into how common virtual currency transactions really are.
Noticing a trend? The IRS is making it a priority to enforce and provide guidance on proper reporting of cryptocurrency transactions. While the guidance in 2019 is a step in the right direction, there are still many questions to be addressed. According to Desmond, the next big guidance will focus on the rules for gross proceeds reporting of cryptocurrency transactions. This subject also is listed in the IRS’ priority guidance plan for 2019-2020.
To stay up to date with IRS guidance on virtual currency reporting, reach out to your BKD Trusted Advisor or use the Contact Us form below.