Just last week, the Internal Revenue Service (IRS) reported that it has begun sending letters to taxpayers with virtual currency transactions. The targeted taxpayers are those that potentially failed to report income and pay tax from virtual currency transactions or those who failed to report their transactions properly.
Virtual currency transactions involve complex tax issues and we have very little firm guidance from the IRS on how to treat these transactions. More detail on the tax implications of virtual currency and the rules we have to date, are at my blog post here. Information about virtual currency and FBAR reporting at my blog post here. The IRS anticipates issuing additional legal guidance in the virtual currency area in the near future. So, stay tuned!
The IRS started sending these so-called “educational letters” to taxpayers just last week and apparently the IRS has been examining tax years 2013-2017. By the end of August, more than 10,000 taxpayers will receive them. The names of these taxpayers were obtained through “various ongoing IRS compliance efforts.” “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”
The “Educational Letters” and What They Really Mean
For taxpayers receiving such an educational letter, there are three variations: Letter 6173, Letter 6174 or Letter 6174-A, all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors. The letters point taxpayers to relevant information on the IRS website, including which forms and schedules to use and where to send them.
Letter 6174 and 6174-A are no-action letters. Essentially this means that if all the reporting and tax obligations have been met, there is no need to respond. Taxpayers could receive these letters even if they have been fully tax compliant.
Letter 6173, however, indicates there has been noncompliance in either failing to file a tax return or a schedule or form reporting the virtual currency transaction. This letter requires that a taxpayer take action. If there is none, the taxpayer will be examined by the IRS. Taxpayers are generally given 1 month to respond.
You can view the Letter 6173 here.
Last year, the IRS’s audit division identified virtual currency as an area where taxpayers could easily avoid taxes. The head of the IRS Criminal Investigation Division, Mr. Don Fort has said the IRS will soon announce criminal tax evasion cases involving such currencies.
Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some (I repeat, some) cases, depending on the facts, taxpayers could be subject to criminal prosecution. Virtual currency has been an ongoing focus area for IRS Criminal Investigation. The problem for those facing criminal exposure is that once they receive the letter from the IRS they are no longer eligible to join the IRS Voluntary Disclosure program because their disclosure submission may not be considered “timely”.
Under the Internal Revenue Manual, a disclosure is timely if it is received before:
- The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation.
- The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance.
- The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer.
- The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
See IRM 22.214.171.124 which can be found here.
Read more about the IRS Voluntary Disclosure program at my blog post. Be very careful before joining this program and do not let panic or an overzealous tax advisor take you there! Definitely obtain a second or third opinion from a qualified tax professional before signing up! In many cases, Voluntary Disclosure is not the way to go – especially in the area of virtual currency where taxpayers lack guidance on how to treat many transactions. Those taxpayers who have not yet received an IRS letter are best advised to seek appropriate tax help as soon as possible. I am available for consultations in this tricky area; contact me directly (all details on my blog website).
The Overseas American and Virtual Currency
Americans living and working abroad may find it difficult to maintain a bank account in their country of residence due to the infamous “Foreign Account Tax Compliance Act”, FATCA. These individuals may more frequently turn to virtual currency to handle payments as more and more goods and service providers are becoming happy to accept it.
Unfortunately, Americans overseas are already in the IRS cross-hairs with respect to their foreign assets or accounts. Adding a foreign virtual currency account to the mix, makes matters more precarious for the American abroad.
POSTED July 30 2019
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