Even in the US, which so far has been more lenient toward cryptocurrencies than China, the noose is tightening. Top Bitcoin exchange Coinbase has decided that trying to defy the law, in terms of not complying with a IRS summons requiring it to turn over information about customers who had engaged in more than $20,000 in Bitcoin transactions in a year, was not a viable position. Apparently Coinbase had had the Silicon Valley libertarian chutzpah to think the rules didn’t apply to them. The IRS does not regard “disruption” as a tax exemption.
Bizarrely, many people who use Bitcoin and other cryptocurrencies labor under the delusion that those transactions aren’t subject to tax reporting and tax compliance. As we reported at the time, in 2014, the IRS determined that Bitcoin was property, not a currency. That meant that gains on trading in Bitcoin are taxable the same way gains on trading in currency futures or selling a piece of land are.1 That means, and that means you, those transactions are reportable as income for US taxpayers.
The supposed virtue of cryptocurrencies like Bitcoin is their Achilles heel as far as hiding from the taxman is concerned. The famed blockchain contains the full ledger for each coin, meaning the history of all transactions, and that record cannot be altered. The blockchain contains the date and time and the amount of each transaction, as well as the unique identifier for the wallet associated with that transaction. Knowing the wallet does not get you to the holder of the wallet, but it gets you a fair bit of the way there. As Lee Sheppard pointed out in Tax Notes last year:
Moreover, many transactions are now settled off the blockchain and never recorded there. The exchange that processed the transactions would have the only records. From an investigatory standpoint, the blockchain’s limitations and the widespread practice of off-chain clearing combine to make the blockchain more like the Depository Trust Company, which holds publicly traded shares on behalf of brokers, who control information about beneficial owners. To find the owner, it is necessary to sue the intermediary in each case.
That isn’t as far-fetched as you might think.
The US Treasury’s Financial Crimes Enforcement Network had stated that cryptocurrency exchanges are money service businesses because they often convert the cryptocurrencies into money. That means in pretty much all cases they are obliged to register and to comply with anti-money laundering rules.
Enter Coinbase. The San Francisco-based company is a virtual currency exchange and a registered money transmitter, and also has licenses in 36 states. It offers cryptocurrency wallets forBitcoin, Bitcoin Cash, Ether, and Litecoin in 190 countries and can buy and sell in 32 countries. It also processes Bitcoin for merchants and offers a Bitcoin debit card.
Last year, the Justice Department issued a summons to Coinbase seeking customer information for users who traded Bitcoin for dollars: transaction details, correspondence, user profiles, account instructions, statements, security settings and the know-your-customer and due diligence record from the account opening. Coinbase called in Congressional air cover, which led to the demand being narrowed to customers who had sold more than $20,000 in a year and excluded the ones who had received 1099s. The Justice Department summons, which included affidavits from an IRS agent, had teeth by virtue of identifying two corporations with Coinbase accounts that had traded Bitcoin without reporting the gains, avoiding paying millions of dollars in taxes by virtue of both depicting their Bitcoin buys as technology expenses. A third dodgy case involved laundering offshore funds into the US.
Last Friday, Coinbase agreed to provide the records on 13,000 customers between 2013 and 2015 in the next three weeks. Some of the reporting on this story is disingenuous. For instance, from MarketWatch:
Because of the current lack of clarity surrounding cryptocurrency and taxes, taxpayers should report the transactions to the IRS no matter how much money they have made, preferably with the help of a CPA, according to Coinbase, which told users it is “unable to provide legal or tax advice.”
Ahem, the IRS position on virtual currencies isn’t ambiguous. But as Upton Sinclair pointed out, “It is difficult to get a man to understand something when his salary depends on his not understanding it.” Some virtual currency users may take comfort in the fact that some exchanges promise anonymity by obscuring wallet information in dark websites. Nevertheless, if you are a US person, you are required to report and pay applicable taxes on virtual currency sales. And unlike a lot of other tax avoidance schemes, you can’t plead any grey-area law to get out of not reporting a profit on the sale of property. So consider yourself warned.
1 Note that what triggers a taxable event is trading in and out of dollars. If you hold Bitcoin or another cyptocurrency and let it fluctuate, or exchange it for another cryptocurrency, the tax man has no interest. It’s when you sell it for dollars, or use it to acquire an asset that has dollar value like a car that you trigger a taxable event. Recall that the IRS is very restrictive on what it deems as non-taxable in property exchanges: they have to be “like for like”.