The Internal Revenue Service could be doing more to help taxpayers who own Bitcoin and other forms of cryptocurrency to comply with their tax obligations, according to a new report from the Government Accountability Office.
The report, issued Wednesday by the GAO, acknowledged that the IRS has provided some guidance in 2014 and 2019 on what it refers to as “virtual currency.” In 2014, it issued Notice 2014-21, which said the IRS would treat Bitcoin and other virtual currencies as property for federal income tax purposes and offered some examples of how long-standing tax principles could be applied to transactions involving virtual currency. Despite dramatic increases, decreases and volatility in the prices of various forms of digital currency such as Bitcoin, it took another five years before the IRS responded to the demand for further guidance in the form of frequently answered questions on virtual currency transactions.
However, part of the 2019 FAQ guidance isn’t considered authoritative because it was not published in the Internal Revenue Bulletin. The IRS has said that only guidance published in the IRB is its authoritative interpretation of the tax laws. The IRS didn’t make it clear to taxpayers that this part of the guidance isn’t authoritative and is subject to change.
The IRS has seen the need for taxpayers to report on their crypto trades and holdings, and for this tax season it added a question to the top of Schedule 1 of Form 1040 asking, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
The current IRS guidance says that using virtual currency can produce taxable capital gains, but the GAO report said the IRS could do more to help taxpayers comply. Financial institutions already report information about investment sales to the IRS and taxpayers, to make both aware of any taxable income. But while some cryptocurrency transactions are reported, far from all of them are.
Taxpayers are required to report and pay taxes on income from cryptocurrency use, but the IRS still has limited data on tax compliance for virtual currency. The information returns filed by third parties, such as financial institutions, generally don’t require filers to indicate whether the income or transactions they report involved cryptocurrency. The IRS launched a virtual currency compliance campaign in 2018 and worked with other agencies on criminal investigations. Last July, the service started mailing more than 10,000 letters to taxpayers with cryptocurrency activity telling them about their potential tax obligations.
However, the IRS and the Financial Crimes Enforcement Network, also known as FinCEN, haven’t clearly and publicly explained when and if the requirements for reporting financial assets held in foreign countries apply to virtual currencies, the GAO pointed out. Clarifying and providing publicly available information about those requirements could improve the data available for tax enforcement and make it less likely that taxpayers will file reports that are not legally required.
The GAO recommended the IRS clarify that part of its 2019 guidance isn’t authoritative and take steps to increase information reporting, and that FinCEN and the IRS address how foreign asset reporting laws apply to virtual currency. The IRS agreed with the GAO’s recommendation on information reporting, but it disagreed with the other two suggestions, arguing that a disclaimer statement is unnecessary and it’s premature to address virtual currency foreign reporting.
“We continue to engage a broad spectrum of external stakeholders for feedback on how the IRS might balance taxpayer service with proper regulatory enforcement of digital assets, including virtual currency,” wrote Sunita Lough, deputy commissioner for services and enforcement at the IRS, in response to the report. “The wide variety of currency exchanges and digital assets pose a challenge to issuing guidance on specific circumstances, but the guidance issued by the IRS to date illustrates how longstanding tax principles associated with the sale, exchange or disposition of property can apply to virtual currency.”
For its part, the GAO said it believes a disclaimer would increase transparency and the IRS could clarify foreign reporting without waiting for future developments in the industry. FinCEN, however, agreed with the GAO’s recommendation. “FinCEN will coordinate with the IRS to determine the best approach to provide clarity to the public regarding the application of the Report of Foreign Bank and Financial Accounts to virtual currency,” wrote FinCEN director Kenneth Blanco in response to the report. “Currently, the FBAR regulations do not define virtual currency held in an offshore account as a type of reportable account.”
The IRS recently removed wording from its FAQ page about the applicability of the rules to virtual currency used in games like Fortnite and Roblox, according to Bloomberg Tax, with an IRS official saying the inclusion of the in-game currency was an error.