As the Use of Cryptocurrency Gains Popularity, IRS Enhances Its Enforcement Procedures
FBAR Reporting Requirement
Every year, under the law known as the Bank Secrecy Act, U.S. persons (includes citizens, residents, corporations, partnerships, etc.) must report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep certain records of those accounts. You report the accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114.
Case of John Doe
A federal court in the District of Massachusetts entered an order authorizing the IRS to serve a John Doe summons on Circle Internet Financial Inc., or its predecessors, subsidiaries, divisions, affiliates, including Poloniex LLC (collectively “Circle”), seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is seeking the records of Americans who engaged in business with or through Circle, a digital currency exchanger headquartered in Boston.
“Those who transact with cryptocurrency must meet their tax obligations like any other taxpayer,” said Acting Assistant Attorney General David A. Hubbert of the Justice Department’s Tax Division. “The Department of Justice will continue to work with the IRS to ensure that cryptocurrency owners are paying their fair share of taxes.”
“Tools like the John Doe summons authorized today send the clear message to U.S. taxpayers that the IRS is working to ensure that they are fully compliant in their use of virtual currency,” said IRS Commissioner Chuck Rettig. “The John Doe summons is a step to enable the IRS to uncover those who are failing to properly report their virtual currency transactions. We will enforce the law where we find systemic noncompliance or fraud.”
What is Cryptocurrency?
Cryptocurrency, as generally defined, is a digital representation of value. Because transactions in cryptocurrencies can be difficult to trace and have an inherently pseudo-anonymous aspect, taxpayers may be using them to hide taxable income from the IRS. The courts have agreed with the IRS that there is a reasonable basis for believing that cryptocurrency users may have failed to comply with federal tax laws.
The IRS issued guidance regarding the tax treatment of virtual currencies in IRS Notice 2014-21, which provides that virtual currencies that can be converted into traditional currency are property for tax purposes. The guidance explains that receipt of virtual currency as payment for goods or services is treated as income and that a taxpayer can have a gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer’s cost to purchase the virtual currency (that is, the taxpayer’s tax basis).
Déjà vu 2007?
When one thinks of Switzerland, images of skiing on snow covered mountain tops, expensive watches or chocolate may come to mind. There was a time when Switzerland was known as a tax haven because of its bank secrecy laws. In 2007, the United States began an intensive tax investigation of Swiss banks when it probed the financial activities of one of the world’s largest banks, United Bank of Switzerland (UBS).
Eventually the IRS, with the enforcement powers of the U.S. Justice and Treasury Departments, began requesting account information from other Swiss banks. By 2009, the number of taxpayers running to their lawyers for advice to avoid criminal prosecution peaked. By 2011, tax haven banks from other countries were complying with providing the Justice Department with their customer’s account information.
How the IRS is Approaching Cryptocurrency Compliance
Cryptocurrency compliance will very likely follow that of the Justice Department’s approach to foreign bank accounts – seeking records of all cryptocurrency exchanges to identify its customer base and potential tax evaders.
What Is Tax Fraud?
To prove tax fraud, the burden is on the IRS to show an underpayment of tax due to an act of the taxpayer to evade the assessment of tax which the taxpayer believed to be owing, that the underpayment act was willful and not a result of inadvertence, reliance on incorrect technical advice, a sincerely held difference of opinion, negligence or carelessness.
Where Does the IRS Go From Here?
The IRS has begun making available on its website and IRS publications information about cryptocurrency and virtual currency. If you click here, you will learn what virtual currencies are and their tax consequences.
Although the IRS has budget restraints, it is hiring agents in its criminal investigation fraud unit to identify potential tax evaders, including cryptocurrency tax evaders.
In addition, the IRS is now using artificial intelligence (AI) technology to more efficiently detect tax fraud, hidden assets, money laundering, identity theft, and other noncompliance. In the past, instances of tax-related criminal activity had to be manually discovered by revenue agents, which could take an inordinate amount of time to process. Now, thanks to AI, the IRS can process data and conduct criminal investigations in a much more efficient manner. The IRS is now deploying machine learning, natural language processing, and graph analytics to successfully identify instances of fraud and illegality before financial loss occurs.
The IRS plans to mine data from tax returns, property returns, bank reports, and even social media accounts. The project will then employ algorithms and AI to identify patterns where taxpayer noncompliance might be present. In addition, the IRS will use natural language processing – technology that enables a computer to read and translate filings, as well as contemplate their meaning, which, will help predict IRS success in its appeals process. Through language processing, machine learning is able to provide indicators of why appeals were either won or lost, and thereby, provide the probability of future success for cases with similar facts. In a cost-conscious environment, the IRS is under pressure to be smarter about how it selects cases that are most likely to conclude well.
Tax Planning Tip #1
Carefully review the questions (and your answers) on your Form 1040 before checking “yes” or “no”. You are signing your tax return as being true and correct under penalties of perjury. If you fail to answer these questions truthfully, you could be accused of committing tax fraud.
Tax Planning Tip #2
Carefully complete your tax professional’s tax organizer each tax year. Due to the U.S. Treasury Department and IRS’s focus on foreign reporting requirements and virtual currencies, it is difficult to envision a tax professional not having a question in the tax organizer inquiring about foreign bank, investment holdings and cryptocurrencies. If you do not understand a question on the organizer, ask for guidance. All of your responses need to be truthful and to the best of your knowledge.
Tax Planning Tip #3
Review the draft of the tax return prepared by your tax professional for completeness and accuracy before signing the return (or the e-file authorization Form 8829). Remember, you are signing your tax return under penalties of perjury that you have examined your return and its attachments, and to the best of your knowledge and belief, that the return is true, correct and complete.
Tax Planning Tip #4
If you would like to learn more about how the IRS recognizes and develops its fraud cases, we suggest you read IRS Internal Revenue Manual Section 25.1.2.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.