Time is not on the side of taxpayers who have not reported their Bitcoin and other virtual currency transactions to the IRS. The IRS recently announced that they are sending letters to virtual currency owners who have not reported transactions on their income tax returns. By the end of August, more than 10,000 taxpayers received these letters.
The IRS refers to the letters as “educational letters” advising the taxpayers to amend their returns. By “educating” these taxpayers, the IRS appears to be setting the table for future, more serious enforcement, such as criminal prosecution, which requires intent or willfulness to evade taxes.
This is the fallout of a November 2017 legal victory for the IRS over Coinbase regarding a customer record subpoena. Coinbase was required to comply with the subpoena, but it is unknown if the IRS has successfully obtained data from other third party exchanges as well. Additionally, the IRS has been performing blockchain data analytics with third party vendors, such as Chainalysis. As a result, the IRS has amassed a large amount of data on virtual currency transactions that it is ready to put to use.
IRS Notice 2014-21 states that virtual currency is to be treated as “property”. Therefore, the general tax principles for property apply to virtual currencies.
Since transactions are reported on tax returns in US Dollars, taxpayers are required to determine the fair market value of virtual currency 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, that exchange rate can be used (but it must be applied in a “reasonable manner that is consistently applied”).
Virtual currency prices are notoriously volatile, therefore, precise data should be used to the extent that it is available and practical (such as price by the hour or price by the minute, rather than an average daily price). Minute-by-minute Bitcoin prices are available on www.coindesk.com by obtaining a daily pricing graph and exporting the information to a .csv file.
Additionally, certain exchanges only price virtual currencies in terms of Bitcoin, rather than in terms of US dollars (i.e. ETH priced at 0.0216 BTC). In those cases, a two-step conversion may be needed, first converting the transaction to Bitcoin and then converting to US dollars.
Be aware… regulatory agencies have not provided that much guidance with regards to digital asset accounting, audit, and taxes. Please reach out to us at firstname.lastname@example.org if you have any questions.