Did You Get an IRS Crypto Warning Letter?
September 20, 2019
The IRS sent a recent round of letters to cryptocurrency investors regarding their reporting obligations. Tim Speiss, Co-Leader of EisnerAmper’s Personal Wealth Group, discusses why someone would receive a warning letter, what they should do, penalties for failing to report, and the long-term tax outlook of cryptocurrency investment.
DP: So let's start from the top, Tim. What is considered cryptocurrency?
TS: Digital currency in which incorruption techniques are used to regulate or generate the transfer of funds.
DP: So bitcoin being one example, but there are several others.
TS: Yes. And by the way, these are done independent of using any bank, so they don't run through any kind of banking system.
DP: Having said that, what's the taxing mechanism for these cryptocurrencies?
TS: Well, it's still considered a financial asset. So with any kind of transaction that would be a financial asset, a person engaging in that transaction would have to report any income from that asset, any gain on the sale of such asset. And any loss on the disposition of such assets.
DP: Anytime you get a warning letter from the IRS, you really should take a second look at that. And when these IRS letters first went out to crypto investors, which was the summer of 2019, they had a little bit of an ominous air about them. What was the IRS message to crypto investors here?
TS: Well, first the initiative by the IRS commenced around this in 2014, so this is not necessarily a new endeavor. What was new was the depth and the breadth of the July mailings, which occurred in the middle of the month went out to about 13,000 investors. That's a rounded number, and there were three types of letters. The most ominous letter was the version whereby the IRS was advising taxpayers that the service was aware of a transaction and encouraged them to file and report. A second version was simply a warning to say that if someone had engaged in a crypto transaction, they should report it. Those were generally the tone and texts of the letters.
DP: And what would trigger someone getting a letter? Is it anyone who engaged in cryptocurrency investment? Was there a threshold?
TS: Well, the information that we're aware of, which was reported fairly broadly, what was that the IRS had obtained records from an entitiy called Coinbase. Coinbase was an entity that actually facilitated these transactions. They’re not the only one, but the IRS had obtained their records and by going through those records identified persons that had transactions where Coinbase was involved — therefore sending those taxpayers one of the versions of the letters.
DP: We don't want to generalize because everyone's case is different, but generally speaking, what should you do if you get one of these letters?
TS: You should certainly respond. There are many taxpayers who genuinely believed that these were not taxable transactions, meaning that they bought or sold a cryptocurrency, that there was no tax reporting in that context. They still would have to report it. And the IRS letter was probably the first time they ever were advised that they had to do so. Other taxpayers, and we've worked with people who have engaged in these kinds of transactions, simply didn't file or were never advised by a tax advisor or anyone else that these were reportable transactions. A cryptocurrency, even though it's the digital currency and is not tangible property, is still a transaction. And, therefore, if you sold cryptocurrencies and you had a gain or a loss, that is a reportable transaction. And that's really what the IRS lettered. That’s what we're trying to educate the recipients about.
DP: Correct me if I'm wrong, but anytime you talk digital, you always have to look at data security. The IRS will send a letter. Correct. So if someone gets an email or a phone call, that's not the IRS protocol, that's a potential scammer.
TS: Correct. And that's a whole different venue because apart from what we're talking about, via crypto, we're aware of taxpayers getting phone calls from callers saying they represent the IRS and they want Social Security numbers. We're aware persons getting phone calls regarding credit cards and asking the same kinds of questions. So you really have to be very careful.
DP: What are we talking about with respect to possible fines and penalties if you're not in compliance?
TS: That's a very wide spectrum. It depends upon a number of factors. First off, there are penalties for failure to file, failure to properly disclose. So even if someone filed a tax return and didn't disclose, there's also penalties and assessments if you've understated a tax liability. So it's a very broad range of potential penalties and fractions.
DP: Now, taking a longer-term look at this, what do you think this means to investors going forward in the crypto area?
TS: Well, first, by comparison, if you sold a stock or a bond, there's usually a reporting trail, a 1099B for example. The bank or the custodian affirming that you transacted with has an obligation to report the transaction. A sale, for example, in the types of transactions we're talking about cryptocurrency, and there are others, there is no such reporting. You could say it's presently not regulated due to the lack of present enforcement around reportings. If you've engaged in a transaction, and we do have to give people the benefit of doubt here, but if you engage in a transaction that's monetary in nature, including crypto, you should generally be thinking about reporting requirements to the Internal Revenue Service.
DP: Good advice. Any final thoughts on this area, Tim?
TS: This is a very broad regime. Now with cryptocurrency, the fact that the IRS identified over 10,000 people, some reports say it was 13,000 letters, just shows you the depth and the breadth that the IRS is focused on ensuring that these types of transactions are being reported. And, as we have said, this initiative goes back to 2014. This is not new, even though the particular letters that we're talking about were issued in July of 2019. The initiative goes much further back than that.
DP: Tim, thanks for your expertise in this quickly moving area. And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.