Cryptocurrency Taxes: The Ultimate Guide to Tax Consequences for Boston Taxpayers
What is at Risk if You are Being Targeted in a Cryptocurrency Tax Audit or Criminal Tax Fraud Investigation?
If you invest in cryptocurrency and you are a U.S. citizen or resident living in Boston, you have obligations to the IRS. The IRS has clearly stated its position that, under the Internal Revenue Code, “U.S. persons are subject to tax on worldwide income from all sources[,] including transactions involving virtual currency.” You could owe tax obligations to local, state and international taxing authorities as well.
The IRS Criminal Investigation Division has identified cryptocurrency tax fraud as an “ongoing focus area,” and in 2019 the IRS began sending warning letters to Bitcoin and other cryptocurrency investors. If you have received a warning letter from the IRS – and even if you haven’t – you need to be extremely careful to avoid substantial penalties and the potential for criminal prosecution.
Are There Serious Tax Implications to Investing in Cryptocurrencies such as Bitcoin?
Cryptocurrency investors need to be aware that failing to report income and pay tax on cryptocurrency investment returns can have severe tax implications. For federal income tax purposes, cryptocurrency holdings are treated similarly to other more-traditional types of investments. If you realize gain when you sell a stock, that is a taxable event. The same holds true when you sell cryptocurrency. As a result, if you have failed to report taxable cryptocurrency transactions to the IRS, then you could be at risk in the event of an IRS audit or a criminal cryptocurrency tax fraud investigation.
What kind of risk are we talking about? Whenever you fail to timely pay tax to the IRS, you are liable for back taxes, interest and percentage-based penalties. If you have been buying and selling cryptocurrency for years, your aggregate liability could be substantial. Furthermore, if there is evidence to suggest that you have knowingly evaded your federal tax obligations (i.e. if you received an IRS warning letter and ignored it), then you could also be at risk for being indicted on charges of criminal tax fraud.
Warning Letters Sent by the IRS for Cryptocurrency Investors and Bitcoin Investors
On July 26, 2019, the IRS announced that it was sending “education” letters to more than 10,000 cryptocurrency investors. It sent three versions of the letter: Letter 6173, Letter 6174 and Letter 6174-A. According to the IRS, “all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors.”
If you have received Letter 6173, Letter 6174 or Letter 6174-A, this means that the IRS has identified you as a cryptocurrency investor who may (or may not) have failed to meet your federal tax obligations in one or more prior years. This is most likely the result of Coinbase turning over more than 13,000 investors’ data to the IRS pursuant to a summons and court order. In order to protect yourself, you must respond to the letter appropriately, as failing to do so could lead to a tax audit or criminal tax law investigation.
What do we mean by responding “appropriately”? Your filing obligations will depend on your personal tax filing history and your history of Bitcoin and other cryptocurrency transactions. If you have met your reporting and payment obligations, then you may not need to file an amended return. However, if you have failed to disclose any taxable cryptocurrency transactions to the IRS, you will need to work with Boston tax lawyer Kevin E. Thorn. He can review your returns from prior years, prepare the necessary amended returns, and determine whether any back taxes, interest and penalties are owed.
What is the Process for Filing Taxes for Cryptocurrency Investments?
In general terms, filing taxes in relation to cryptocurrency investments is no different from filing taxes for any other type of investment income. You must report all taxable events on your federal returns (and state and international returns, if applicable), and you must pay either ordinary income or capital gains tax on all income that is subject to tax under the Internal Revenue Code.
However, filing taxes for cryptocurrency investments presents challenges for many individuals. This is because accurately reporting and calculating tax on cryptocurrency transactions requires the following information (this list is not exclusive):
- The date of the original investment (purchase or acquisition in exchange for goods or services)
- The purchase price of the initial investment (the original “tax basis”)
- The date of transfer (either sale of the cryptocurrency or exchange for a product or service)
- The fair market value (FMV) of the cryptocurrency at the time of transfer
In order to accurately file taxes for cryptocurrency, this information is needed for each individual cryptocurrency transaction. For someone who trades in cryptocurrency regularly, this could potentially mean hundreds or thousands of transactions over a multi-year period that need to be reported to the IRS. Since most exchanges and digital wallets do not track all of this information (particularly FMV at the time of acquisition or sale), cryptocurrency investors must track much of this information themselves in order to meet their tax reporting and payment obligations.
The Importance of Working With a Boston Tax Lawyer Who Can Provide Cryptocurrency Tax Assistance
With these types of issues in mind – and understanding the potentially-substantial tax, interest and penalty obligations that come with failing to timely report cryptocurrency transactions – most cryptocurrency investors will benefit greatly from the assistance of an experienced tax lawyer. This is true with regard to prospectively addressing tax reporting issues, retrospectively amending incomplete tax returns, responding to IRS warning letters, and defending against audits and investigations.
An experienced tax lawyer will be able to help you with cryptocurrency-related tax compliance in numerous respects, including:
- Determining which of your cryptocurrency transactions qualify as “taxable events” that need to be reported to the IRS
- Determining whether you have any local, state or international tax obligations related to your cryptocurrency investments
- Assessing your potential exposure and executing an effective strategy with regard to disclosing previously-unreported cryptocurrency transactions
- Filing all necessary new and amended tax returns
- Representing you in direct communications with the IRS and other tax authorities, including during tax audits and criminal tax investigations
- Negotiating offers in compromise and deferred prosecution agreements (if necessary and in your best interests)
- Developing tax strategies for avoiding future issues at the state, federal and international levels
Do You Owe the IRS Back Taxes, Interest and Penalties Related to Your Cryptocurrency Investments? Could You Owe Taxes Overseas? Call 617-692-2989 to Find Out.
Frequently-Asked Questions (FAQs): Federal Income Tax and Cryptocurrency
Q: How Does the IRS Audit Bitcoin and Other Cryptocurrency Investors?
Currently, the IRS appears to be focusing its auditing efforts on cryptocurrency investors whose identities were released pursuant to the Coinbase subpoena. However, we expect the IRS to expand the scope of its cryptocurrency audits in the future; and, if you own cryptocurrency (or have owned cryptocurrency) in the past, then a “normal” tax audit could involve scrutiny of your cryptocurrency-related holdings and transactions as well.
Q: Is Gain on Bitcoin and Other Cryptocurrency Investments Taxable Income?
Since Bitcoin and other cryptocurrency investments are treated similarly to stocks and other investment vehicles for tax purposes, gain on Bitcoin and other cryptocurrency investments is taxable to the same extent as gain on these other types of investments.
Q: How is Cryptocurrency Taxed?
Cryptocurrency itself is not taxed. Rather, transactions involving cryptocurrency are considered taxable events, at least at the federal level in the United States. Tax laws vary widely between jurisdictions; and, in order to understand your tax obligations, you will need to work with an experienced tax attorney.
Q: In Which Jurisdictions Must You File Tax Returns Related to Cryptocurrency?
As a U.S. citizen or U.S. resident, you are subject to federal income tax on “worldwide income from all sources.” If you live in a state that has income tax, you may also need to file in your state; and, due to the global nature of cryptocurrency, you may have international tax filing obligations as well.
Q: How Do I Account for Cryptocurrency Gains?
As we discussed above, accounting for cryptocurrency gains is one of the biggest challenges many investors face when it comes to tax reporting and compliance. As a general rule, cryptocurrency investors should maintain transaction logs that are as detailed as possible; and, once again, it is advisable to seek advice from an attorney with specific experience in this area.
Q: Isn’t Cryptocurrency Supposed to be Anonymous?
Not to the extent that most people currently expect. While certain aspects of the blockchain technology underlying cryptocurrencies are designed to protect anonymity, the recent Coinbase subpoena makes clear that it still possible to identify cryptocurrency investors.
Q: Can You Write Off Cryptocurrency Losses on Your Taxes?
Since cryptocurrency is treated similarly to other types of investments for tax purposes, cryptocurrency losses can generally be written off to the same extent as losses on other types of investments.
Contact Boston Tax Attorney Kevin E. Thorn, Managing Partner of Thorn Law Group
Have you received an IRS warning letter? Are you concerned about tax consequences related to your cryptocurrency investments? To speak with Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group in confidence, call 617-692-2989 or inquire online now.