There is much confusion over how to tax a new form of currency. This new form of currency, referred to as cryptocurrency, involves the use of digital currency like Bitcoin. Investors purchase Bitcoins and use them to make other purchases in the marketplace or to sell at a later date. These forms of digital currency are purchased with the hopes of making a profit in the future.
As with most monetary transactions, a tax likely applies. Unlike most transactions, this one is more difficult to track. One of the draws with digital currency is the anonymity. Among other things, there is generally not a third party document to aid the Internal Revenue Service (IRS) in tracking transactions that involve virtual currency. A 1099, for example, does not accompany the sale of Bitcoins. This makes it very difficult for the IRS to track these transactions and ensure users are in compliance with tax obligations. This has led the IRS to accuse some virtual currency investors of attempts to thwart their tax obligations.
Furthermore, as noted in a recent piece in Mondaq, these transactions can fall under the purview of various tax laws. Depending on the details of the trade, in addition to documentation for capital gains an FBAR may also be required.
In an effort to ensure tax compliance, the IRS requested federal court approval to issue a “John Doe” summons on one of the biggest digital transaction institutions, Coinbase. The request was approved. The IRS now hopes to gather personal information from Coinbase on all of the institution’s digital currency users.
Congress steps in, questions IRS: Although it appeared the summons would move forward, members of Congress stepped in and requested additional information from the federal agency.
Congressional leaders within the Senate Committee on Finance as well as the House Committee on Ways and Means sent the IRS Commissioner a letter questioning whether the IRS “established a reasonable basis to support the mass production of records” requested within this summons. Mass, indeed. The summons translates to a request of records from approximately 500,000 people. Ultimately, the lawmakers stated the summons appeared “overly broad, extremely burdensome, and highly intrusive to a large population of individuals.”
Taxpayers beware; lawmakers still support taxation of digital currency: Taxpayers should not misinterpret this letter. Previous letters have chastised the IRS for its failure to properly tax these transactions in the first place. Congress is not stating that the agency should back down from pursuing taxes from these transactions, but that it should do so more wisely.
Ultimately, those who partake in transactions with virtual currency should heed this debate as a warning. These transactions are scrutinized by the IRS. The IRS is not only ironing out proper tax regulations for this new form of currency, but likely kicking off investigations into questionable transactions. As such, anyone partaking in the use of digital currency is wise to seek legal counsel to ensure they are in compliance with applicable tax laws.