IRS Taking a Closer Look at Digital Currency

Bitcoin is the world’s most widely used “cryptocurrency.” A what, you may ask? A cryptocurrency is where encryption regulates the creation and transfer of a digital currency without the use of paper money or a central bank. Bitcoin exists based on the value users place on it.

Bitcoin’s peer-to-peer structure utilizes a blockchain, essentially an electronic ledger that is publicly distributed, which is independently verified by individual users. Users will have their Bitcoin transactions associated with unique alphanumeric addresses that get stored in electronic wallets. This is designed to create a level of anonymity and decentralized control for users. 

The IRS, however, views Bitcoins as property. Thus, any gain or loss of such from transfers should be reported on an individual’s tax return. Due to the anonymity associated with Bitcoin, many users may not be reporting this information appropriately—whether intentionally or not. The IRS has investigated digital currency as part of ongoing tax evasion investigations and recently asked a federal court to stipulate that a leading Bitcoin wallet service (Coinbase) submit user data. A federal judge approved this request in November 2016. However, there was something different about this request: the scope. The IRS is trying to compel Coinbase to release all customer and transaction data from 2013 to 2015.

As part of its normal registration procedures, Coinbase should have been collecting basic user information. Combine this with transaction data and it may be possible to associate a specific user with a specific wallet and transactions. (A similar “John Doe Summons” revealed the names of UBS account holders in Switzerland, resulting in more than $10 billion in tax collections.)

Coinbase users argue that the IRS request was too broad and compromised privacy. The IRS has filed subsequent motions to counter the users’ positions on privacy.  A judge plans to hear both sides’ motions in early 2017. 

One possible ruling could result in an amended IRS request targeting only Coinbase’s largest customers. Nevertheless, there’s little doubt that the IRS is more closely examining potential tax evasion via digital currencies. A recent report from the Treasury Department calling for the IRS to develop a virtual currency strategy has only given the IRS more impetus to act.