Coinbase, one of the country’s largest exchanges for cryptocurrencies like Bitcoin, must turn over the account information of more than 14,000 customers to the Internal Revenue Service (IRS). The agency requested the records as part of its ongoing efforts to crack down on alleged tax evaders.

IRS Cryptocurrency Enforcement Initiative

According to the IRS, just 800 to 900 taxpayers reported their Bitcoin gains from 2013 through 2015 by filing Form 8949, which is used for reporting sales and other dispositions of capital assets. This figure stands in stark contrast to the number of U.S. taxpayers who may owe taxes on cryptocurrency transactions. According to Coinbase, it has approximately 5.9 million customers and has facilitated $6 billion in Bitcoin transactions. 

In an effort to address the alleged non-compliance with U.S tax laws, the IRS issued a “John Doe Summons” to Coinbase seeking records on all of the company's transactions between 2013 and 2015. The virtual currency exchange refused to comply, citing the privacy of its customers. In a recent court order, a California district court ordered Coinbase to turn over the records for all customers who made a transaction worth $20,000 or more between 2013 and 2015. Coinbase has estimated that this request would total 8.9 million transactions between 14,355 different account holders. 

In a blog post, Coinbase characterized the court order as a partial victory, noting that the government was forced to vastly narrow the scope of its summons. “The government’s own lawyers noted at the hearing that the IRS is not accustomed to having to fight for records in this context, and most companies just turn records over without going to court,” the company wrote. “Thanks to Coinbase’s efforts, more than 480,000 customers’ records were preserved from disclosure. This is a 97% reduction in the number of customers impacted by this summons.” 

IRS Virtual Currency Guidance 

For taxpayers who don’t want to face a potential enforcement action, the IRS has published guidance regarding how virtual currency should be treated for federal tax purposes. It states that virtual currency is considered property rather than currency for federal tax purposes. Accordingly, general tax principles applicable to property transactions apply to transactions using virtual currency. 

The guidance, IRS Notice 2014-21, further provides that a taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, taxpayers are required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.

The IRS virtual currency guidance also advises that a taxpayer may have gain or loss upon an exchange of virtual currency for other property. “If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain,” the agency explains. “The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.”

The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes the capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.

Of course, this article provides only a brief overview of the potential tax consequences of virtual currency. Business and individuals that engage in Bitcoin or other virtual currency transactions should consult with an experienced tax attorney to address any additional compliance concerns. As with any potential tax issue, it is always wise to be proactive rather than wait for the IRS to come knocking.

If you have any questions or if you would like to discuss the matter further, please contact me, Jeffrey Pittard, at 201-806-3364.