The IRS Targets Another 10,000 Cryptocurrency Users in Letter Campaign

News, Opinion | August 20, 2019 By:

More news on the IRS’ ongoing efforts to tax virtual currency broke in July – this time, it was revealed that the agency had been sending out thousands of letters accusing (or, suggesting…) certain taxpayers of misreporting their cryptocurrency earnings. While this action may come as a surprise to those unfamiliar with the IRS’ activities over the past few years, it has long been anticipated by those keeping up-to-date.

Like many government organizations around the world, the agency has been playing catch-up with the space and those operating within it, for some time. Given that cryptocurrency functions independently from the legacy financial system by design, the efficiency of the attempts to police it is questionable – methods being used are either not enough, or too invasive. 

At first glance, the IRS’ demands to exchanges to turn over data on US citizens seem like an effective approach, but the reality is much more complex – there are more than 250 exchanges operating globally, and while most trading activity takes place on these, users also turn to other avenues like decentralized exchanges (DEX) or direct peer to peer transactions(P2P). In both cases, no authority exists for the IRS to demand data.  By receiving information on a user from a single platform, it’s highly unlikely that a full picture of the individual’s activity is being painted. At scale, identifying users in this manner is inefficient.

Tax related documents being issued to traders are not new. Last year, 1099-Ks were received by users of some exchanges that met a certain threshold for transactions. However, the recent letters cast a wider net that serve more to spook cryptocurrency users than to educate the public. Though the targeting may be vague, it should be taken seriously by recipients.

Those issued so far come in three different flavors – 6173, 6174, and 6174-A. In 6173, the agency speaks with certainty in asserting that back taxes are owed. The latter two are more benign, stating that the IRS believes that the taxpayer may owe taxes based on their activities. Interestingly, they have given us some further insight into the tax agency’s stance on cryptocurrencies, clarifying that the exchange of one cryptocurrency for another is a taxable event – this has long been a point of contention amongst experts, stemming chiefly from the (now outdated) Section 1031 from the IRS code, which did not perceive crypto-to-crypto trades to be taxable.

The 6174  letters offer something of a grace period wherein no further action will be taken if returns are amended. Of course, the guidance provided by the IRS for the purposes of filing taxes is vague at best, and incomplete at worst. Worse still, the 6173 letter gives taxpayers 30 days to navigate this guidance to report correctly, with an optional 30 day extension granted upon request.

The letters were not well-received by the public. In a now-deleted thread, an alleged IRS employee took to Reddit to discuss the agency’s incompetence, describing the current action as a ‘fishing expedition’ driven chiefly by guesswork and fearmongering, and suggests that the data they rely on is of poor quality. True or not (the poster has not been verified) the thread illustrates the position some are taking. .

If the thread is to be believed, it only reinforces a problematic stance adopted by the IRS: one that favors sanctions over education. We saw another, more alarming, example of this last month, too, when a Twitter user shared a presentation on the aggressive techniques being explored by the agency to identify cryptocurrency users.

There surely comes a point when tracking tax evaders to this extent is justified, but it’s hard to rationalize it when it appears to be a disorganized scare tactic, particularly when the IRS has stalled in explaining to traders how to file taxes. Such is the frustration of stakeholders in the space that even members of Congress have demanded clarification on the topic. The IRS has promised an imminent overhaul of their guidance as a result, but it remains to be seen whether they’ll follow through.

In the interim, investors can do little other than read up on the sparse guidelines available in the 2014-21 memo and begin to amass a complete record of past transactions. For users with higher volume, it’s recommended that they use software-driven solutions to pull logs from exchanges and offline/online wallets and subsequently calculate their gains. If they have the option to, the safest way forward is simply to consult an accountant familiar with crypto taxes.

Cryptocurrency tax law is in dire need of structure. The IRS needs to establish fair standards and work to educate taxpayers, not point fingers.