The IRS has announced that it has begun sending letters to taxpayers that may have failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.
Background. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. It can sometimes operate like "real" currency, i.e., the coin and paper money of the U.S. or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance. However, virtual currency doesn't have legal tender status in any jurisdiction. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as "convertible" virtual currency. Bitcoin is a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
Notice 2014-21, 2014-16 IRB, provides that virtual currency is treated as property for U.S. federal tax purposes, and that the general tax principles that apply to property transactions apply to transactions using virtual currency. (Notice 2014-21, FAQ No. 1) Virtual currency isn't treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes. (Notice 2014-21, FAQ No. 2)
A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value (FMV) of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. (Notice 2014-21, FAQ No. 3)
IRS has been concerned that taxpayers selling, exchanging, or othewise disposing of virtual currency have not been properly reporting those transactions.
Educational letters. The IRS has started sending educational letters to taxpayers. By the end of August, more than 10,000 taxpayers will receive these letters. The names of these taxpayers were obtained through various ongoing IRS compliance efforts.
There are three variations of the educational letter:
- Letter 6173-sent to taxpayers when, for one or more of tax years 2013 through 2017, IRS has not received either a federal income tax return or an applicable form or schedule reporting the taxpayer's virtual currency transactions.
- Letter 6174-sent to taxpayers when IRS has information that the taxpayers have or had one or more accounts containing virtual currency but may not know the requirements for reporting transactions involving virtual currency.
- Letter 6174-A-sent to taxpayers when IRS has information that the taxpayers have or had one or more accounts containing virtual currency but may not have properly reported the transactions involving virtual currency.
All three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors.
Taxpayers are pointed to appropriate information on IRS.gov, including which forms and schedules to use and where to send them.
Last year the IRS announced a Virtual Currency Compliance campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations. See IRS adds five new issues to L&BI's campaign audit strategy.
Virtual currency is an ongoing focus area for IRS's Criminal Investigation division.
IRS adds that taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.