The Internal Revenue Service is seeking information from more taxpayers who hold virtual currency like Bitcoin, but in a ruling last week, a judge ordered the IRS to limit its summons for information from one cryptocurrency exchange, Bitstamp.
The case involves a taxpayer who filed an amended return asking for a $15,475 tax refund for taxes he had already paid on his crypto transactions. The IRS audited him and discovered an unreported transaction on Bitstamp in 2016, according to Bloomberg Tax. The IRS filed a summons with Bitstamp to learn further information about the taxpayer, but he petitioned in June to block it, prompting the IRS to move to enforce the summons.
Judge John Coughenour said the IRS summons was too broad. “The summons requests information that is irrelevant to the IRS’s stated purpose of auditing Petitioner’s 2016 amended return,” he wrote in an order. “The summons is therefore overbroad.” He gave the IRS 14 days to amend its summons.
The IRS has been cracking down on cryptocurrency users who may be evading taxes, sending warning letters after receiving information from another major cryptocurrency exchange, Coinbase, which fought a long court battle with the IRS after the IRS sent a John Doe summons seeking information on all of its customers. That information request was also limited somewhat by the courts before Coinbase ultimately turned over information.
The IRS also recently released long-awaited guidance on the taxation of cryptocurrency, following up on a 2014 notice, along with a draft tax form. (See IRS issues more guidance on cryptocurrency and IRS revises Form 1040 schedule to ask about cryptocurrency.)
But the new guidance didn’t go far enough for many taxpayers: “I think that this addresses some issues that hadn’t been addressed by prior guidance, but based on what I’m hearing, there’s still a lot of questions,” said Rochelle Hodes, a principal in the Washington National Tax Office at Crowe LLP, in a recent interview. “There’s also interest in the form of the guidance that came out. It’s really a form that doesn’t provide binding guidance that taxpayers can rely on. It’s rather a form of guidance that states the IRS position. In some respects some of the really hard questions were not answered. In other respects, the positions that the IRS took were not informed by input from the public. From practitioners, from folks who are in the industry, and from the taxpayer perspective there is a lot of dissatisfaction with the guidance that’s come out.”
Hodes also pointed to the guidance on so-called “hard forks” and “airdrops.”
“In the revenue ruling, for instance, on the hard fork, the question about how the amount of the new coin received as a result of a hard fork should be treated is a complex question,” she said. “The government position put forth in the revenue ruling is it’s income the second you get it, and you measure the value of that income on the date and time of when you get it. So you’ve got this recognition event. They did provide some rules that sound like the Section 451 receipt concept talking about dominion and control.”
However, Hodes noted that the IRS is now dealing with the cases it has developed from the John Doe summons and the letters it has sent out to the taxpayers whose information came back from Coinbase in response to the summons.
“They’ve got cases in the pipeline,” said Hodes. “They’ve got all of the cases that they’ve developed from the Coinbase summons. They’ve got whatever the responses that are coming back to the 10,000 letters. They have cases in enforcement now and this is showing you what position they are taking, and that’s all well and good, but as far as determining what’s the best or right tax answer, and what’s best for tax administration, getting specific public input and putting out an answer would have been helpful. The answer in the FAQs, for instance, they have an example of an exchange in one virtual currency for another is going to be treated as income for any delta in the value at the point in time of the transaction. While they didn’t say it, that’s premised on the decision by the government that trading one virtual currency for another is not a like-kind exchange. We all know a like-kind exchange got removed in the TCJA, but at the time of the hard forks and prior to TCJA, like-kind exchange was something that a lot of folks were looking at as far as is this the proper tax treatment. It would have been nice if they had some input on that topic.”
She also objected to the IRS guidance on airdrops, which doesn’t match up with industry practice. “The whole concept of an airdrop following a hard fork is a unicorn,” said Hodes. “That’s not how it happens. Perhaps public discourse could have provided an ability for the IRS to be more accurate. Based on information that I’ve gleaned, it appears that the airdrop concept is really the IRS’s label for when somebody gets the new coin. But all of that noise about the incorrectness I think takes away from the position that’s being put forward and the discussion about what are the right answers.”
IRS chief counsel Michael Desmond reportedly indicated at two recent tax conferences that he is open to reconsidering the guidance to align it more with industry practice on airdrops and hard forks, according to Cointracker. But Hodes thinks that it may be too late for many taxpayers.
“It would have been nice to hear all of this before the guidance came out in a form that is not binding, can’t be relied upon and basically is putting the IRS’s marker on how they’re going forward on enforcement,” she said.
Hodes added that she would also like to see the IRS offer something like a voluntary compliance program, as it did with its crackdown on foreign bank accounts, to help taxpayers come into compliance: “Voluntary compliance is an important piece of the overall compliance puzzle.and that’s missing,” said Hodes. “The other piece that is missing is acknowledging that taxpayers had viable positions to take prior to the date of this guidance for not reporting the gains, losses, etc., so it appears that the only tax way the IRS has for people to come into compliance for prior years is to file an amended return and take into account all of that income based on their rules today.”
“There is no relief,” she continued. “There is no acknowledgment that today the value of the coins that they have could be significantly lower than at the time they had a potential recognition event. There’s nothing. There’s no safe harbor. Getting people to come into compliance in tax administration is a multipronged exercise. One part of that exercise is strong enforcement, and where appropriate, making a big stink about the criminal cases. There are going to be far fewer criminal cases, but when those are made an example, that serves a lot for deterrence, and also to get everybody else to pay attention and realize that this is what they should be doing, and then strong enforcement so that people don’t feel like suckers if they comply. But that’s not the only tool. The other tools are education and outreach.”