written on behalf of Feigenbaum Law
The Internal Revenue Service has published a new report in which the Information Reporting Program Advisory Committee (IRPAC) emphasized the rise in popularity of Bitcoin and other cryptocurrencies and noted that there has been a concurrent rise in questions about the tax consequences around transactions involving these virtual currencies.
What is IRPAC?
IRPAC is a federal advisory committee under the broader umbrella of the IRS. It’s mission is to “provide an organized public forum for discussion of relevant information reporting issues of mutual concern as between [IRS] officials and representatives of the public”.
IRPAC provides observations and recommendations on current and proposed IRS policies, programs, and procedures, and responds to draft IRS regulations and notices. It regularly issues reports, such as the one in question.
Cryptocurrency is Property for Tax Purposes
The IRS previously issued a notice in 2014 indicating that cryptocurrencies would be treated as a form of property for tax purposes. General tax principles that apply to property transactions also apply to transactions using virtual currencies. The CRA has issued similar guidelines on cryptocurrency.
This meant, among other things, that:
- Wages paid to employees via virtual currency would be taxable to the employee, must be reported by the employer, and are subject to withholding and payroll taxes at the federal level;
- Payments to independent contractors and other service providers via virtual currency are subject to self-employment tax rules;
- How gains or losses from sale or exchange of virtual currency will be treated will depend on whether that currency is a capital asset;
- Any payments made using virtual currency is subject to information reporting in the same manner as any other payment.
Consistent Questions Remain Despite Prior Guidance
In its report, IRPAC acknowledged and thanked the IRS for the above notice, but noted that “many industry and tax practitioners still question other tax consequences of cryptocurrency transactions”.
Frequent asked questions identified by IRPAC included:
- Can cryptocurrency be considered a specified foreign financial asset?
- How is the basis determined for cryptocurrency that is sold?
- Does broker reporting apply to cryptocurrency transactions?
IRPAC also identified significant “open issues” that also require further analysis and guidance, particularly in terms of reporting. These include:
- Whether virtual currency held for investment is a capital asset;
- Whether virtual currency should be treated as a security;
- Whether virtual currency should be subject to or not subject to the wash sale rules or be affected by market implications under section 475;
- Whether virtual currency should be considered a financial account for FATCA purposes;
- Whether a taxpayer can use LIFO or FIFO to determine the basis of virtual currency sold;
- Whether a taxpayer can contribute virtual currency to an IRA.
It was as a result of these and other queries, that IRPAC recommended that the IRS issue further guidance on the tax consequences of cryptocurrency transactions.
Tax Consequences of Cryptocurrency Transactions
The IRPAC report cites a recent article which identified the significant tax consequences of virtual currency transactions. Cryptocurrency related tax liabilities in the U.S. were estimated at $25 billion (based on approximately $96 billion of taxable gains for U.S. cryptocurrency investors who comprise around 30% of cryptocurrency investors worldwide).
IRPAC noted that whether or not this estimate is accurate, it clearly emphasizes the need to gain more information on the operations of these protocols to ensure that any applicable taxes are efficiently collected. If you assume a 50% noncompliance rate, potentially unreported tax liabilities stemming from cryptocurrency represent about 2.5% of the estimated $458 billion tax gap.
IRPAC notes in the report that “many, if not most, taxpayers will report these activities correctly if they are able to determine the implications of their cryptocurrency activities”, but does note that some may be tempted to do otherwise, particularly as virtual currency transactions have an inherently anonymous aspect and are difficult to trace. For instance, taxpayers may use cryptocurrency exchanges outside of the jurisdiction of the U.S.
IRPAC notes that several countries have raised similar concerns and may be considering cooperating with one another to address tax evasion and other issues. IRPAC indicates that it would be “very interested in helping develop information reporting and withholding guidance on these important issues”.
We will continue to follow developments in this matter. In the meantime, if you have questions about how investing in Bitcoin or other emerging currencies will affect your current tax plan contact Feigenbaum Law. We are leaders in the field of tax law, and offer services to clients in the US, Canada and around the world. Contact us to learn more about how we can help or call us at (416) 777-8433 or toll-free at (877) 275-4792.