Many of my readers are aware that I have written various blog posts about the US tax issues that surround virtual currency. Some have asked, (perhaps innocently, perhaps not), about so-called “third party reporting” of virtual currency to the Internal Revenue Service (IRS) . For those who do not know what this means – it’s a simple concept. In many cases, the US tax law requires that third-party payers report to the IRS those payments they have made to others. Financial institutions and other third parties are to report interest payments, property sales, and other transactions to both taxpayers and the IRS using forms known as information returns.
Taxpayers are much more likely to report their income when they receive third-party notification of payments they received. Common information returns include Form W-2 (employer paying an employee wages), Form 1099-DIV (corporation paying dividends to its shareholder) Form 1099-INT (financial institution paying interest income).
Virtual Currency – The Current State of Third Party Reporting to IRS
Currently, the IRS does not receive information returns on potentially taxable transactions involving virtual currency. This of course, limits its ability to detect noncompliance. Some virtual currency exchanges send information returns to IRS and to customers that provide information about customers’ trading activity, but many others do not.
In February 2020, the United States Government Accountability Office (GAO) submitted its report (GAO-20-188) on virtual currencies to the Ranking Member, Committee on Ways and Means, House of Representatives. Part of the report detailed findings of GAO’s review of websites for nine major U.S.-based virtual currency exchanges:
As of November 2019, two exchanges had policies posted online stating that they report information for some of their customers’ virtual currency transactions to IRS on Form 1099-K. One exchange stated that it reports customers’ transactions on Form 1099-B, a more detailed information return that provides a breakdown of individual virtual currency transactions. Another exchange’s website stated that it provides Forms 1099, but does not identify the form more specifically. Three exchanges’ websites had policies stating that the exchanges do not report customers’ transactions on tax forms. The remaining two exchanges did not state on their websites whether or not they file information returns or provide customers with tax forms.
Possible Forms that can be implicated in virtual currency transactions include those in the Forms 1099 family. For example:
- Form 1099-K, Payment Card and Third Party Network Transactions. Third parties that contract with a substantial number of unrelated merchants to settle payments between the merchants and their customers are required to issue a Form 1099-K for each merchant that meets the threshold of having more than 200 transactions totaling more than $20,000 in a year.
- Form 1099-B, Proceeds from Broker and Barter Exchange Transactions. Brokers use Form 1099-B to report transactions such as sales or redemptions of securities, regulated futures contracts, and commodities. For certain types of property, brokers must also report cost basis information on Form 1099-B if the information is required.
- Form 1099-MISC, Miscellaneous Income. Certain payments made in the course of a trade or business—including rents, prizes, and various other types of income—must be reported by the payer on Form 1099-MISC. For most types of income subject to reporting on Form 1099-MISC, payers must file the form only if they made payments totaling at least $600.
Tax practitioners interviewed by the GAO generally stated that it is not clear whether current US Treasury Regulations require virtual currency exchanges to report customers’ trading activity on Forms 1099-K or 1099-B. According to IRS officials, virtual currency exchanges may be subject to the 1099-K reporting requirement if they fall into the legal category of “third party settlement organizations.” Exchanges are subject to the 1099-B requirement only if they are brokers or barter exchanges. IRS does not have an official position on whether virtual currency exchanges are required to report customers’ trading activity on Form 1099-B. There may also be ambiguity regarding when, if at all, reporting on virtual currency sales is required on Form 1099-MISC.
Some transactions, such as transferring virtual currency directly to a merchant in exchange for goods, generally create no obligation to file any information returns. Other virtual currency transactions, such as sales of virtual currency for cash through virtual currency exchanges, may be subject to third-party reporting requirements. However, those requirements are not entirely clear, and people have interpreted them differently.
Even if exchanges are subject to the 1099-K, 1099-B, or 1099-MISC reporting requirements, these requirements do not cover all taxable transactions. Third-party settlement organizations, for example, are required to file Form 1099-K only for customers who make more than 200 transactions in a year that total more than $20,000. Taxable transactions below that threshold may not be reported. With regard to Form 1099-B, some transactions carried out by brokers do not need to be reported on Form 1099-B unless they involve cash. For example, taxpayers must report trades between different virtual currencies on tax returns, but brokers may not be required to report such trades on Form 1099-B.
Foreign Virtual Currency Exchanges
Unless owned by a US payor (including a so-called “controlled foreign corporation“), virtual currency exchanges operating outside the United States are not required to file information returns such as Forms 1099-K or 1099-B unless, according to the GAO report, the customer or transaction has certain connections to the United States. Bitfinex, for example, is a cryptocurrency exchange owned and operated by iFinex Inc., which is headquartered in Hong Kong and registered in the British Virgin Islands. By contrast, Coinbase, Binance and Kraken are US-based cryptocurrency exchanges.
Changes on the Horizon
Virtual currency is currently on the IRS hot list. It is one of the IRS “campaigns” and criminal investigations related to crypto have already started. The IRS has been sending taxpayers “educational” letters to remind them and warn them of their tax obligations when it comes to the use of virtual currency. Until third-party reporting of virtual currency is implemented, many transactions will slip through undetected.
The GAO report suggested the IRS take steps to increase third-party reporting on taxable transactions involving virtual currency, including clarifying IRS’ interpretation of the existing third-party reporting requirements. IRS agreed with this recommendation. One of the items on the Department of the Treasury 2019–2020 priority guidance plan is guidance regarding information reporting on virtual currency. Perhaps once COVID-19 is under control we will see this being implemented.
The GAO also recommended that the IRS should clarify the application of reporting requirements under the Foreign Account Tax Compliance Act (FATCA) to virtual currency. This is a direct hit on virtual currency exchanges operating outside the US to report on their US customers in the same manner as foreign financial institutions (such as foreign banks) do currently. The IRS disagreed with this recommendation and felt it was appropriate at this time to only focus guidance on information reporting transactions with respect to US exchanges/ US businesses and US taxpayers. According to the IRS, as the workings of foreign virtual currency exchanges become more transparent in time, additional FATCA guidance might be appropriate in the future. Let’s see!
FinCEN is on the Case
We do know that the Financial Crimes Enforcement Network (FinCEN) will soon require that foreign accounts holding virtual currency must be disclosed on the Report of Foreign Bank and Financial Accounts (FBAR, Form 114). No doubt about it, things will tighten up.
FinCEN has also recently proposed rules requiring banks and “money service businesses” to report virtual currency accounts involving “unhosted” wallets or held in wallets hosted in a foreign jurisdiction identified by FinCEN as suspicious for money laundering and other nefarious purposes. Initially, the Foreign Jurisdictions List would be comprised of
jurisdictions designated by FinCEN as jurisdictions of primary money laundering concern (i.e.,
Burma, Iran, and North Korea), but could in the future be expanded to include jurisdictions that are identified to have regulatory deficiencies warranting concern. Generally the proposal would subject such wallets to know-your-customer (KYC) requirements and reporting requirements for certain transactions. To ensure that transactions are not undertaken anonymously, FinCEN’s proposed rules also cover “structuring” transactions entered into in order to get around the reporting requirements. A good summary is here.
Call to Action
If you have not been properly reporting virtual currency transactions, now is the time to make things right. Once the IRS comes calling, it is much harder to escape penalties. Email me if you need assistance email@example.com
Posted February 25, 2021
All the US tax information you need, every week –
Just follow me on Twitter @VLJeker (listed in Forbes, Top 100 Must-Follow Tax Twitter Accounts 2017-2021).
Subscribe to Virginia – US Tax Talk to receive my weekly US tax blog posts in your inbox. My blog specializes in foreign and US international tax issues.
Visit my earlier US tax blog “Let’s Talk About US Tax” hosted by AngloInfo since 2011, it contains all my old posts. Some hyperlinks to my blog posts on AngloInfo may have expired. If you copy the expired URL, you can most likely retrieve the actual post by using the “Wayback Machine” which is an archiving service. Simply paste the URL into the Wayback Machine search box. It will show you the archived post was saved on a specific date. Click on that date to retrieve the post.
You can access my papers on the Social Science Research Network (SSRN) at https://ssrn.com/author=2779920