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IRS agrees to major cryptocurrency strategy overhaul following audit

The US Treasury Inspector General for Tax Administration (TIGTA) recently released a scathing report detailing an audit of the Internal Revenue Service (IRS) strategy for addressing income produced through virtual currencies.

The US Treasury Inspector General for Tax Administration (TIGTA) recently released a scathing report detailing an audit of the Internal Revenue Service (IRS) strategy for addressing income produced through virtual currencies.

“Bitcoin automated teller machines in shops, malls, and service stations and on college campuses are providing consumers with easy access to bitcoins,” states TIGTA. “These virtual currencies essentially allow taxpayers to pay for the goods and services they need in the same way as traditional currencies.”

The 31-page report is the result of a nine month review of the IRS, conducted between October 2015 through June 2016. TIGTA interviewed IRS management in the Large Business and International Division, the Small Business/Self-Employed Division, Criminal Investigation, and the Office of Chief Counsel.

Treasury Inspector General for Tax Administration Logo“None of the IRS operating divisions have developed any type of compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currencies.”
— – Treasury Inspector General for Tax Administration

TIGTA has only existed since 1998 but was created under the IRS Restructuring and Reform Act to watch for corruption inside the IRS itself, like a police department’s Internal Affairs division. “[We are] committed to the prevention and detection of fraud, waste, and abuse within the IRS and related entities,” the department states.

Although the group is a section of the same government, under the same Treasury department, TIGTA reports directly to the Secretary of the Treasury and is mandated to provide independent oversight of IRS activities. Part of their mission statement is to provide audits, investigations, and inspections and evaluations, ensuring that the IRS is accountable for the trillions of dollars in tax revenue it collects each year.

The recent audit reprimands the IRS for it’s lack of action after establishing the Virtual Currency Issue Team, and issuing Virtual Currency Guidance. “There has been little evidence of coordination between the responsible functions to identify and address, on a program level, potential taxpayer noncompliance issues for transactions involving virtual currencies,” the report reads.

While the Financial Crimes Enforcement Network supplied the first guidance for people who administer, exchange, and use digital currencies in March 2013, there were no official taxation rules in the US until March 2014 when the IRS published their Virtual Currency Guidance, Notice 2014-21.

These 16 rules declared that all virtual currencies were to be taxed as property, as opposed to currencies. Payments made to contractors and service providers had to be reported, and profits and losses from their sale became subject to capital gains tax. Wages paid to employees in digital currencies also had to be reported.

“It does not appear that any of the actions already taken by the IRS to address virtual currency tax noncompliance were coordinated to ensure that the IRS maintains a strategic approach to the tax implications of virtual currencies.”
— – Treasury Inspector General for Tax Administration

The basic guidance document issued many discouragingly-complicated instructions needed to properly handle virtual currencies. The guidance states that receiving virtual currencies for payment requires computing their gross income including the fair market value of each payment in virtual currency, as “measured in U.S. dollars, as of the date that the virtual currency was received.” Miners also had to calculate a fair market value, “as of the date of receipt is includible in gross income.”

While merchant payment platforms like Bitpay and Coinbase help ease the problem by helping to calculating the size and time of these payments through their platforms, the overwhelming majority of digital currency users have to work hard to stay compliant. Finding the Fair Market Value and the Basis of each payment made with digital currencies can easily become overwhelming for bitcoin users who use it as a currency instead of a long-term investment.

While many bitcoin users have been ignoring these rules, businesses are forced to choose between complying or refusing to use the currencies. The current process is so burdensome that the NY Times suggested that it might kill bitcoin off single-handedly.

“Due to the potential complexity of reporting otherwise simple retail purchase transactions related to virtual currencies, further guidance is needed to help taxpayers voluntarily comply with their tax obligations.”
— – Treasury Inspector General for Tax Administration

The report also highlights IRS inaction following a request for comments to Notice 2014-21 from the public, “No actions were taken to address the comments received.” TIGTA reviewed all the comments and found several examples of information requested by the public that would be helpful in understanding how to comply with the tax reporting.

In addition, third-party methods of reporting taxable transactions do not separately identify transactions related to digital currencies. While employers and businesses are required to report taxable virtual currency transactions, current third-party information reporting documents, like the W-2 and 1099, do not provide the IRS with any means to identify that the taxable transaction amounts being reported were specifically related to virtual currencies.

The report also revealed that a Virtual Currency Issue Team (VCIT) was established in December 2013. It was created by the IRS’s offshore department to learn how virtual currencies may affect international taxable transactions. In the years since, VCIT has been training agents how to detect offshore money laundering using cryptocurrencies. At least 200 Large Business and International Division employees and more than 300 Special Agents have been through the training so far.

However, when TIGTA recently followed up with the IRS’s Criminal Investigation Management department to learn what steps had been taken to identify taxpayers that are using virtual currency to “Dodge taxes,” TIGTA was informed that, “Nothing specific has been done.”

“It is imperative that the IRS ensures that those who engage in activities using virtual currencies comply with all of their tax obligations.”
— – J. Russell George, Treasury Inspector General for Tax Administration

TIGTA made three very specific recommendations for the IRS, which were all agreed to at the end of the document. The agency recommends that the IRS develop a specific, “Virtual currency strategy,” that is coordinated with all of the IRS divisions.

The strategy must include outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation. The deployment date suggested for these changes is by September 30, 2017.

The second recommendation focuses on the taxpayer’s discouraging experience. TiGTA tells the IRS to “Provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies.”

The report points out that the previous tax rules and documentation for taxpayers were insufficient, with an example of how a taxpayer using bitcoin to buy a daily cup of coffee would have to determine what portion of which bitcoin was used to make the purchase based on a daily exchange rate, converting it all into dollars, and keeping records of it all to calculate gain and loss when reporting.

“Due to the potential complexity of reporting otherwise simple retail purchase transactions related to virtual currencies, further guidance is needed to help taxpayers voluntarily comply with their tax obligations.” The deployment date suggested by TIGTA for this updated guidance is by December 30, 2016.

“Notice 2014-21 does not provide taxpayers with guidance on what records should be kept and how the records should be maintained.”
— – Treasury Inspector General for Tax Administration

The third and final recommendation focused on third-party business reporting of their customers, such as when your boss or your bitcoin exchange reports your earnings. TIGTA noted that forms for employers and other businesses to use for tax reporting, including 1099’s and the W-2, do not have a line for virtual currencies to be reported. They recommended the IRS “Revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.”

“Revising existing information reporting documents to require employers, businesses, and third-party settlement organizations to identify virtual currency transaction amounts would provide the IRS with some of the data necessary to analyze the risk of taxpayer reporting noncompliance regarding virtual currencies,” states TIGTA.

The forms mentioned in their example are some of the most common taxpayer documentation seen year to year by the public, including the basic earnings statements and employment ID tax forms.

Unfortunately, while agreeing with the sentiment, the IRS’s Douglas W. O’Donnell of the Large Business and International division, who was responding to TIGTA, refused to enact the third recommendation, citing a lack of funds.

Inland Revenue Service Logo“In our current fiscal climate, the IRS is faced with competing funding priorities, and this reduced funding has required a need-based prioritization Of Information Technology expenditures. Modifying information reporting documents to capture Virtual currency amounts not a priority at this time.”
— – Douglas W. O’Donnell, Internal Revenue Service


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