Coinbase customers be aware, a federal district court has ruled that a version of the IRS’s summons can be enforced.
In its continued press for greater tax compliance in the virtual currency arena, the IRS issued Notice 2014-21 which stated that transactions involving virtual currency shall be treated no different than any other transaction involving intangible property whereby a gain or loss must be recognized at the time of a taxable event. This notice currently serves as the single most authoritative guidance for those who have dealt with cyber currency and want to be in compliance with current tax regulations.
Over the last few years the IRS has continued to identify several tax compliance risks associated with transactions involving crypto currencies, including, but not limited to, a lack of third party reporting. The IRS claims that without third party reporting it is very difficult, if not impossible for the agency to identify taxpayers who are not in compliance with their tax obligations. In an effort to alleviate a portion of this risk, the IRS issued a summons to Coinbase Inc., a virtual currency exchange company based out of San Francisco, CA. This summons was recently granted (in part) by a federal district court in which it required Coinbase Inc. to produce the names, birth dates, addresses, tax ID numbers and other information for all accounts with transactions in excess of $20,000.
With the recent gain in popularity and interest in crypto currencies, we are frequently asked by our clients how best to stay in compliance with current tax requirements. Our first response always begins with the importance of maintaining adequate documentation to support every purchase, sale, trade or receipt of cyber currency. We often find clients who are simply unaware of the taxable events that occur when trading cyber currency. While every transaction is unique, we routinely explain to our clients the impact IRS Notice 2014-21 has on their unique situation.
Notice 2014-21 states that transactions in virtual currency are no different from any other property transaction that results in gain or loss. In other words, any virtual currency received as payment for goods or services must include the fair market value of the virtual currency (in U.S. dollars) as of the date the virtual currency was received. If a virtual currency is sold, a taxable gain (or loss) will occur at the time of sale or trade so long as the payment received is greater than (or less than) the original purchase price.
“If a virtual currency is sold, a taxable gain (or loss) will occur at the time of sale or trade so long as the payment received is greater than (or less than) the original purchase price.”
While the IRS notice seems straight forward at face value, many fail to realize that if a virtual currency is purchased and subsequently transferred into an exchange where it is used to buy a different virtual currency, a taxable gain (or loss) must be recognized. Furthermore, every time a cyber currency is sold, whether in an exchange or through a peer-to-peer transaction, a taxable gain (or loss) must be recognized. In contrast to the belief that a taxable event only occurs when cyber currencies are sold and US dollars are received, each time a cyber currency is traded, a taxable gain (or loss) must be recognized.
Take for example someone who makes a deposit into their Coinbase wallet, by purchasing either, Bitcoin, Bitcoin Cash, Ethereum, or Lite Coin. As is the case with many, while this person bought Bitcoin, what they really wanted was to buy an alternative coin, say for example Ripple which is currently not available on the Coinbase exchange. So what do they do? They transfer their newly purchased Bitcoin out of their Coinbase wallet and deposit it into a different exchange such as Binance which has a marketplace for Ripple. What many fail to realize is that when they sell their Bitcoin on the Binance exchange for Ripple, a (gain or loss) must be recognized. For those who frequently trade cyber currencies, this can present a daunting task when having to maintain the necessary record keeping since it is the taxpayer (not the IRS) who has the burden of proving the cost basis.
Continuing with our example, say this same person wants to “cash out” of the Ripple they acquired and get US dollars. First, they sell their Ripple back into the Binance exchange for Bitcoin. This again results in a taxable event and a gain (or loss) must be recognized. Remember, the goal of this individual was to get US dollars so they then transfer their Bitcoin out of Binance and put it back into their Coinbase wallet. After the Bitcoin is back in their Coinbase wallet, they then sell it for US dollars. When this final sale of Bitcoin occurs, they again, are required to recognize a gain (or loss).
“For those who frequently trade cyber currencies in exchanges, this can present a daunting task when having to maintain the necessary record keeping since it is the taxpayer (not the IRS) who has the burden of proving the cost basis.”
Without appropriate documentation or credible evidence supporting cost basis, the IRS could essentially take the position that the total value of the cyber currency received in an exchange is fully taxable because it has no basis. Thus, it is critical that adequate books and records establishing a taxpayer’s adjusted basis of their virtual currency (or cost to purchase the virtual currency) be maintained since it determines the amount of taxable gain or loss. Moreover, taxpayers with copious amounts of unreported income over several years, could also be subject to criminal investigation.
Tax payors who are concerned about the tax ramifications associated with their transactions involving cyber currencies are encouraged to be proactive and take the necessary steps to comply. At Covault, we have a team of experienced CPAs who work diligently to ensure all of our clients adhere to the necessary tax filing requirements.