IRS maintains focus on cryptocurrency

| 4/22/2021
IRS maintains focus on cryptocurrency

There has been a significant uptick in IRS news involving cryptocurrency this spring, including the following highlights.

IRS clarifies prior guidance on hard forks and determining value

On April 9, the IRS released a Chief Counsel Advice (CCA) that clarifies two confusing points from cryptocurrency guidance issued during 2019.

First, the CCA clarifies Revenue Ruling 2019-24, which provides that a holder of cryptocurrency who experienced a hard fork followed by an airdrop had taxable income equal to the value of the cryptocurrency received if the taxpayer had dominion and control over the new cryptocurrency. Confusion existed regarding whether the revenue ruling’s holding applied only if a hard fork is followed by an airdrop. The CCA clarifies that “the specific means by which the new cryptocurrency is distributed or otherwise made available to a taxpayer following a hard fork does not affect the Revenue Ruling’s holding.” Accordingly, the holding in Revenue Ruling 2019-24 applies in cases when there is a hard fork that is not followed by an airdrop, which was the typical case and the situation surrounding Bitcoin hard forks in 2017 and 2018.

The CCA also clarifies an IRS frequently asked question (FAQ) published on the IRS website in 2019 relating to determining a cryptocurrency’s fair market value. Specifically, FAQ 27 provides that in a peer-to-peer transaction, one acceptable method to determine a cryptocurrency’s fair market value is to use a “cryptocurrency or blockchain explorer.” This language was unclear, and in the recent memorandum the IRS clarifies that a taxpayer can use any reasonable method, such as a “cryptocurrency data aggregator,” to determine fair market value. This terminology is much clearer because although a blockchain explorer tracks transactions, it generally does not track value.

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Unreported cryptocurrency is predicted to increase tax gap to $1 trillion

The IRS commissioner made a splash this month with his announcement that he believes that the tax gap – the difference between the tax that should have been timely paid and the amount that was paid – will be $1 trillion when the next estimate is released in 2022. That number was stunning considering the latest official tax gap estimate based on 2011-2013 data was only $441 billion. The IRS commissioner attributed part of this increase to unreported cryptocurrency, which along with cryptocurrency-related summonses, provides a heads up on increased IRS enforcement.

IRS demands information about cryptocurrency exchange account holders

In 2016, the IRS issued a John Doe summons on the cryptocurrency exchange Coinbase for information about its account holders. After some wrangling in court, Coinbase produced information on 13,000 accounts, providing the IRS with valuable data to enhance its cryptocurrency enforcement efforts. Based on the information gathered from Coinbase, the IRS sent 10,000 letters advising taxpayers that they might be subject to tax with respect to their cryptocurrency transactions and that they should amend their returns if income from those transactions was not previously reported.

The IRS recently issued similar John Doe summonses to two other cryptocurrency exchanges, Circle Internet Financial Limited and Payward Ventures Inc. (commonly known as Kraken). The U.S. District Court of Massachusetts authorized the summons on Circle, while the summons on Kraken is still before the U.S. District Court of Northern California. It is likely that any account holder information the IRS obtains through these summonses will lead to further cryptocurrency examinations and other enforcement efforts.

Looking ahead

Given the fact that the IRS commissioner has identified cryptocurrency noncompliance as a source of the nearly $600 billion increase in the tax gap, IRS compliance and enforcement focus on cryptocurrency is likely to continue. In the meantime, taxpayers still are waiting for additional guidance on technical questions about the tax treatment of cryptocurrency transactions, including information reporting. However, it appears that other priorities might be slowing down work on this guidance. Taxpayers will have to work closely with their tax advisers to comply with the rules for the treatment of cryptocurrency transactions.

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Rochelle Hodes
Rochelle Hodes
Principal, Washington National Tax
Tiffany Richardson
Tiffany A. Richardson
Trudie Kanter
Managing Director