IRS enforcement of cryptocurrency and cryptoassets, enforcement is on the rise. In August 2019, the IRS issued more than 10,000 letters to taxpayers it suspected of failing to report or misreporting cryptocurrency transactions. The IRS may also confront the anonymity of parties involved with digital currencies by sending a court-ordered summons for information to companies that facilitate or deal in digital currency transactions. Companies entering the brave new world of digital currency should be extra vigilant with reporting obligations because regulator scrutiny is proving to be much more intense compared to other types of oversight.
How We Got Here
Cryptocurrencies came into play ahead of their financial accounting and tax guidance, and some of the recent crackdown on cryptocurrency users could be attributed to regulators’ efforts to play catch-up. Recent enforcement generally has involved information reporting by companies involved with the transactions, and the individual tax obligations resulting from cryptocurrency investments and/or transactions paid for with cryptocurrency.
The problem for companies that invest in or accept cryptocurrencies is that historically these companies have not had much to go on when it comes to what they should be reporting. For now, the Financial Accounting Standards Board (FASB) appears to be holding off on comprehensive accounting guidance, despite requests from groups including the California Society of CPAs. The IRS provided some early tax guidance in 2014, and released updated information about tax treatment of cryptocurrencies in Revenue Ruling 2019-24 last fall. It concurrently released some frequently asked questions around virtual currency holdings and transactions. But even before the IRS provided the updated guidance in 2019, it initiated a compliance campaign in 2018, targeting virtual currency transactions.
Part of the reason for the early regulatory enforcement comes down to the nature of virtual currencies and cryptocurrencies. Unlike traditional currencies, virtual currencies are not regulated by a governmental agency. Values for cryptocurrencies fluctuate dramatically, and attract investors who are particularly sensitive to movements in the geopolitical and regulatory landscape.
There are also no centralized controls for cryptocurrency transactions because the technology used to record the transaction — blockchain — is secure and encrypted. The technology protects the transaction from the risk of fraud, but blockchain’s level of encryption also makes it nearly impossible for an outsider to determine the parties involved in the transaction. As such, cryptocurrencies have notoriously been used in black market operations.
Cryptocurrency Summons
The IRS is pursuing virtual currency tax compliance on multiple fronts. In addition to the notice letters, the IRS can obtain a court-ordered summons to produce information, skirting the issues of virtual currency users’ anonymity with these so-called “John Doe” summons. A John Doe summons requires companies to turn over the names of parties involved in transactions that the IRS cannot identify. For instance, the IRS used a John Doe summons in 2017 to solicit the names of the customers of Coinbase, a digital currency exchange. The agency similarly attempted to gather information via a John Doe summons from the European digital exchange company Bitstamp.
Takeaways for CFOs
The bottom line in any case is this: if you use cryptoassets in any way, be prepared to report that activity to the IRS. Organizations and individuals that invest in cryptocurrencies should be prepared to report any gains or losses on their cryptocurrency investments. The IRS considers cryptocurrency as property, so the tax reporting will be similar to purchases and sales of stocks and other capital assets. If your organization accepts cryptocurrency as legal tender — which is becoming more common in the retail space — the transaction should be reported in the cryptocurrency equivalent of the fair value of the product in U.S. dollars at the day of the sale.
CFOs with cryptocurrency considerations may consider enlisting the help of an experienced tax and accounting provider for additional assistance. In the absence of substantive guidance from the FASB, some accounting practices resort to self-developed guidelines that address cryptocurrency for financial reporting.
For more information about cryptocurrency tax and reporting risks, please contact us.
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