Cryptocurrency is a virtual currency or digital value that serves as a medium of exchange, amount of wealth or measure of account or value. Virtual currency may act like a monetary currency, but it is not considered legal tender in the United States or anywhere else in the world. Holders of virtual currency exchange and use cryptocurrency similar to the way legal tender is exchanged and used; for example, it can be exchanged for dollars, exchanged for goods and exchanged for services; and digital value can be in an account held for investment purposes. Crytocurrency has been in the news a lot lately because of its volatility and the eyes of regulators around the world. Many countries around the world have been eyeing the virtual currency space for possible more scrutiny and possibly intense regulation.
In the United States the Internal Revenue Service issued IRS Notice 2014-21 as its early guidance regarding transactions in virtual currency. In this Notice, the U.S. Treasury defined cryptocurrency as a commodity and not as legal tender. It is defined as property! In other words; although digital currency is exchanged like money it is not treated like legal tender in U.S. tax law; it is treated as a commodity. The sale, purchase, and use of virtual currency have real tax consequences under U.S. federal tax law. As a commodity, virtual currency is property, and as such, it is subject to the general tax principles applicable to property transactions. That means that gains and losses realized in virtual currency transactions are subject to U.S. federal tax laws. Virtual currency holders may incur tax liabilities based on their holding, transferring, and using virtual currency because the Internal Revenue Service utilizes general tax principles applicable to property transactions with respect to transactions in virtual currency such as bitcoin.
More-and-More these days as governmental regulators’ glare intensifies on virtual currency; cryptocurrency issues have been playing out in court proceedings in the United States. It appears that regulators around the world have begun taking more notice of virtual currency. In late 2017, in a case in the United States District Court for the Northern District of California, the United States Treasury sued Coinbase, Inc. to obtain its customers’ information by summon for several years. The IRS in Coinbase was attempting to enforce a government summons pursuant to 26 U.S.C. Sections 7402(b) and 7604(a). There were approximately 10,000 customers related to the Coinbase summon. The government sought to obtain the following records (on a shortened summons; the IRS reduced or modified the original summons served on Coinbase, Inc.) according to Court documents:
- Account/wallet/vault registration records for each account/wallet/vault owned or controlled by the user during the period stated above limited to name, address, tax identification number, date of birth, account opening records, copies of passport or driver’s license, all wallet addresses, and all public keys for all accounts/wallets/vaults.
- Records of Know-Your-Customer diligence.
- Agreements or instructions granting a third-party access, control, or transaction approval authority.
- All records of account/wallet/vault activity including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, the names or other identifiers of counterparties to the transaction; requests or instructions to send or receive bitcoin; and, where counterparties transact through their own Coinbase accounts/wallets/vaults, all available information identifying the users of such accounts and their contact information.
- Correspondence between Coinbase and the user or any third party with access to the account/wallet/vault pertaining to the account/wallet/vault opening, closing, or transaction activity.
- All periodic statements of account or invoices (or equivalent).
These six items are verbatim text of the document or information request sought by the IRS in United States v Coinbase, Inc. et al,, Case No. 17-cv-01431-JSC. The IRS argued that it needed to know all this information with respect to Coinbase’s customers because the IRS “is conducting an investigation to determine the identity and correct federal income tax liability of United States persons who conducted transactions in a convertible virtual currency … for the years ending December 31, 2013, 2014 and 2015.” The IRS lawyers argued that the “IRS believes that virtual currency gains are underreported.”
The District Court in Coinbase was sympathetic to the IRS’ “legitimate purpose of investigating the reporting gap between the number of virtual currency users Coinbase claims to have had during the summons period and U.S. bitcoin users reporting gains or losses to the IRS during the summoned years.” The Judge therefore ordered Coinbase to release the account holders identity, name, date of birth, taxpayer identification information and address to determine whether a taxpayer properly reported digital currency gains and losses. Although the Court did not, in this particular case, rule completely in the IRS’s favor, yet; it appears clear that the Court could allow the IRS to obtain additional information such as, the information set forth above in Requests 1 through 6 in future rulings in this case, if they are able to show taxpayers are likely not complying with federal tax laws or other laws. Federal tax compliance appears to be the only issue in this case. Are taxpayers dealing and investing in cryptocurrency complying with U.S. federal tax laws? Cryptocurrency and compliance with U.S. federal tax laws are under scrutiny.
This Court case demonstrates that the IRS is examining federal tax compliance with respect to transactions in virtual currency. Cryptocurrency transactions are subject to general property tax principles under U.S. tax laws and those who transact in convertible virtual currency, like bitcoin, must demonstrate compliance with U.S. tax laws because summons pursuant to 26 U.S.C. Sections 7402(b) and 7604(a) are enforceable in federal district courts against virtual currency exchanges, investors and users of cryptocurrency.
This law blog is written by the Taxation | Litigation | Immigration Law Firm of Coleman Jackson, P.C. for educational purposes; it does not create an attorney-client relationship between this law firm and its reader. You should consult with legal counsel in your geographical area with respect to any legal issues impacting you, your family or business.
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