Is the IRS crackdown on crypto traders a sign of a maturing market?

The US tax authority sent letters to over 10,000 digital currency investors warning them that they may have broken federal tax laws if they did not accurately report their cryptocurrency investment incomes, according to a press release published by the IRS on July 26.

The IRS wants its cut

“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties. The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations,” IRS Commissioner Chuck Rettig said in the statement.

There are three variations of the IRS letter to crypto investors: Letter 6173, Letter 6174 and Letter 6174-A. Each letter is aimed at helping recipients understand their tax obligations, and correct potential filing errors.

North Carolina-based CPA Jim Buttonow, who runs the tax blog IRSMind, has broken down what each letter means in plain English. In a blog post, he explained what each of the three notices mean:

Letter 6174 acts as a soft notice that suggests that the taxpayer may have not accurately reported their crypto asset earnings and advises the taxpayer to check their filings and make any amendments if necessary.

Letter 6174-A acts as a not-so-soft notice that suggests that the taxpayer may have misreported their crypto asset earnings and states that the IRS may follow up with enforcement action in the future.

Letter 6173 informs the taxpayer that they have been identified as noncompliant, which means the recipient is required to respond to the letter to prove that they have complied with the relevant tax laws.

The IRS wishes to give investors a chance to repay any potential outstanding taxes owed and the IRS is sending a clear warning to crypto traders who think that they can get away without declaring their crypto holdings. While the IRS may not have the resources to go after every crypto traders suspected of non-compliance, the fear of an audit is generally a strong incentive for taxpayers to comply.

“The IRS clearly does not have the resources to audit all of these taxpayers and needs to understand how to best to achieve compliance. The IRS knows that the goal is to get taxpayers to voluntarily comply. A soft notice program educates taxpayers and encourages voluntary compliance without penalties,” Buttonow added.

He recommends that taxpayers who receive the notices should amend their filings if necessary and should respond to Letter 6173 and 6174-A to avoid an IRS audit.

Are the 10,000 recipients Coinbase users?

The IRS stated that the names of the individuals in questions “were obtained through various ongoing IRS compliance efforts.” However, anecdotal evidence on social media suggests that the 10,000+ affected are the Coinbase users whose details were shared with the IRS after an IRS summons forced the exchange to hand over names, birth dates, taxpayer IDs, addresses, and transactions histories of approximately 13,000 customers in February 2018.

A bitcoin investor who received a letter shared their experience talking to an IRS agent about the notices and was able to provide further insight into who the notices were sent to.

Under the username “zipzapbloop”, the Coinbase user stated on Reddit: “I just got off the phone with a very kind IRS agent who explained much of what we’ve already gathered. If you got 6174 or 6174-A, then unless you have good reason to believe you didn’t comply, then treat the letters as essentially informational. She stated that their resources are very limited and even said that the letters were sent to some 13,000 who had Coinbase accounts. Yes, she actually said "Coinbase accounts."

A sign of a maturing market?

While no one gets excited about having to deal with the taxman, the IRS letters may be yet another sign of a maturing cryptographic asset market and can be considered as a positive for bitcoin.

Most taxpayers report capital gains for their investments in stocks, bonds, and property without blinking an eye. However, when it comes to digital assets, that has not been the case.

Whether it is the pseudonymous nature of most blockchain networks, the Libertarian leanings of some bitcoiners, or the fact that bitcoin is seen by some as “magic internet money,” US crypto traders have a history of not reporting their investment returns.

The IRS campaign to encourage crypto traders to file their capital gain taxes is a sign that crypto assets are considered legitimate investments. If the IRS was not convinced that crypto assets are here to stay and become a part of the global capital markets, it would not go to the lengths it is now to ensure tax compliance.