Will Cryptocurrency Abuse be an Enforcement Focus for the IRS this Tax Season? Blog Subject to Inquiry – Lexology (registration)

Tax filing season began January 23rd, and with its arrival the IRS began rolling out its annual list of the so-called Dirty Dozen. The Dirty Dozen list is an educational effort to inform the public about scams, but it also offers insight into the tax enforcement issues on the IRSs radar.

Particular tax schemes often stay on the Dirty Dozen list for years until the IRS devises an effective strategy for combatting them (if it ever does). Changes on the list reveal new schemes or enforcement priorities that have caught the IRSs attention.

Of particular interest this year: whether cryptocurrency abuse will make the list. Cryptocurrencies, of which Bitcoin is the most well-known, are digital currencies not backed by any government. They trade on public markets called exchanges, and their use has grown rapidly in recent years. The IRS taxes cryptocurrency like property, not foreign currency.

The IRS is presently litigating a summons case against Coinbase Inc., a prominent U.S.-based cryptocurrency exchange, in the Northern District of California. The IRS uses John Doe summons procedure when it believes some type of transaction is being used for tax avoidance, and it wants to find out the identities of currently-unknown taxpayers who have participated in those transactions. John Doe summonses have used to sniff out the identities of, for example, taxpayers using debit cards linked offshore, or holding accounts at certain banks suspected of abuse.

The IRSs resort to John Doe procedure suggests it views cryptocurrency dealing as a widespread tax evasion strategy. But its evidence to date proves only isolated abuse, not pervasive tax evasion. The IRSs summons is supported by interviews with 3 taxpayers who admitted to using cryptocurrency to avoid or evade taxes. But its demand for records is far broader: all cryptocurrency transactions with a U.S. jurisdictional hook at a large cryptocurrency exchange over a 3 year period.

Based in part on this mismatch of the IRSs evidence and the information it demands, some cryptocurrency users and Coinbase itself are litigating to fight the summons. But such efforts seldom succeed at blocking disclosure.

If the IRS viewed cryptocurrency as a common tool for tax abuse, one might expect it to serve John Doe summonses on other US-based cryptocurrency exchanges or payment applications. But it has not done so, probably for lack of evidence they have been abused. Of course, such evidence could emerge from new interviews or from Coinbase records, once produced and digested.

The IRSs disclosures to date create real questions about just how widespread cryptocurrency-based tax fraud really is. If the IRS includes cryptocurrency abuse on its dirty dozen list, it will be sending a signal that it views the Coinbase litigation not as a one-off skirmish, but the first front in a lengthy war to come.

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Will Cryptocurrency Abuse be an Enforcement Focus for the IRS this Tax Season? Blog Subject to Inquiry - Lexology (registration)