The Internal Revenue Service announced today that it has begun mailing what it calls “educational letters” to taxpayers with cryptocurrency transactions who potentially failed to report income and pay the resulting tax from such transactions, or did not report their transactions properly. The IRS started sending these letters to taxpayers last week. By the end of August, more than 10,000 taxpayers will receive these letters. The IRS said it obtained the names of these taxpayers through “various ongoing IRS compliance efforts,” but did not specifically identify such efforts.

The unnamed “compliance efforts” referred to in today’s IRS announcement no doubt include the well-publicized “John Doe” summons served on Coinbase by the IRS. In late 2016, a federal judge authorized the IRS to serve a “John Doe” summons on Coinbase, the largest U.S.-based cryptocurrency exchange, based upon the IRS’s belief that numerous taxpayers were evading taxes by investing in Bitcoin and other cryptocurrencies. After the parties engaged in a year of contentious litigation challenging the summons, a federal judge ultimately ruled in the IRS’s favor, and ordered Coinbase to turn over the names of approximately 13,000 of its customers to the IRS.

Today’s IRS announcement included a stern warning from Commissioner Chuck Rettig. “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

For taxpayers receiving an educational letter, there are three variations: Letter 6173, Letter 6174, or 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, and advise such taxpayers to file amended returns and pay back taxes.

The IRS also reminded taxpayers that last year it announced the creation of a Virtual Currency Compliance campaign to focus on tax noncompliance related to the use of cryptocurrency. At the time, the IRS stated that it would address noncompliance in this area through outreach and audits, and further stated that “[t]axpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical.”

According to today’s announcement, the IRS will be issuing additional legal guidance on the tax treatment of cryptocurrency transactions in the near future. To date, the IRS has issued only a single guidance document on cryptocurrency. IRS Notice 2014-21 states that cryptocurrency is property for federal tax purposes and provides guidance on how general federal tax principles apply to cryptocurrency transactions.

The IRS concluded today’s announcement by stating that it will remain actively engaged in addressing noncompliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations. In addition, the IRS warned that cryptocurrency is an ongoing focus area for IRS Criminal Investigation, and that taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest, and in some cases could be subject to criminal prosecution.

Individuals who receive one of these “educational letters” from the IRS should proceed cautiously, as such letter may be a precursor to enforcement activity, such as an audit or even a criminal investigation. Fox Rothschild’s tax controversy and white collar criminal defense attorneys have significant experience dealing with IRS audits and criminal investigations. Please contact Matthew D. Lee if you receive correspondence from the IRS or have questions regarding the tax treatment of cryptocurrency.

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