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Crypto tax avoiders face IRS roulette: Fess up or try hiding

More than 10,000 cryptocurrency investors face a decision as they open letters from the IRS informing them that they may owe taxes on their digital holdings.

Should they quickly file amended tax returns correcting prior omissions or mistakes and hope that’s enough to avert an audit? Should big-time dodgers come forward and acknowledge their actions — all while risking that the IRS might audit them or charge them with criminal tax evasion?

What about investors who didn’t get a letter, but think they might have failed to report some cryptocurrency investments? Should they quickly sneak in an amended or delinquent return?

“For 90% of people it’s not worth the time or the effort to fight or hide from the IRS,” said James Creech, a tax lawyer in San Francisco. “Amend the returns, take the lumps, pay the tax and penalties and consider yourself lucky to have crypto gains instead of crypto losses.”

The warning letters, which the IRS started sending in late July, represent a new front in the agency’s attempts to curb tax evasion involving virtual-currency transactions. The IRS has been slow to stay abreast of the evolving industry as it has exploded in size and value.

But cryptocurrency tax compliance is now a priority. IRS criminal chief Don Fort has described digital and virtual currencies as a “significant threat” to tax collection and said the agency will soon announce criminal tax evasion cases involving them. In 2017, the IRS won a lawsuit that required digital currency exchange Coinbase to hand over data on customers who bought or sold at least $20,000 in cryptocurrency during any year from 2013 to 2015.

A logo sits on the windows of the offices of La Maison du Bitcoin bank in Paris, France.
A logo sits on the windows of the offices of La Maison du Bitcoin bank in Paris, France, on Thursday, Nov. 23, 2017. Zimbabwe, where the price of bitcoin spiked to double the international rate after last week's military takeover, shows cryptocurrency skeptics where the real-world use of bitcoin, and possibly its future, lies. Photographer: Christophe Morin/Bloomberg

It’s unclear how much in unpaid taxes is owed by crypto investors. The $11.1 billion collected from more than 56,000 Americans who voluntarily confessed to dodging taxes through offshore bank accounts over the previous decade “is one analogy, which I don’t think is a crazy one,” said Robert Wood, a tax lawyer in San Francisco.

The agency’s likely goal is to force crypto tax evaders into compliance rather than prosecute them, said Guinevere Moore, a tax litigator at Johnson Moore in Chicago. But future criminal cases could be levied against some of the 10,000 letter recipients.

The IRS took two distinct tones in the letters. Some mailings informed recipients that they may have tax obligations of which they weren’t aware and simply urged them to file an amended or delinquent return.

Another version took a harsher approach. Those letters give recipients a deadline to respond in writing and reveal everything about their crypto dealings from 2013 through 2017. And they must do so under penalty of perjury — a sign that the nation’s tax collector may think they’re concealing high-dollar transactions that the agency could potentially turn into a legal test case.

The letter also warns that the agency will crosscheck the taxpayer’s response against information “received from banks, financial advisors, and other sources for accuracy” and warns of the potential for audits.

People with lots of virtual-currency transactions they haven’t previously reported shouldn’t amend their returns — that’s basically admitting that you committed a crime, Creech said.

“The IRS generally looks for very strong cases at the outset if they are considering criminal prosecution,” said Mark Matthews, a tax lawyer at Caplin & Drysdale and a former deputy IRS commissioner.

People who received a harsh letter should immediately talk to a lawyer, not an accountant, about potentially disclosing their taxable crypto investments, Matthews said. “If a taxpayer has engaged in knowing and willful tax evasion involving virtual currency, they can enter the most recent voluntary-disclosure program announced last fall” by the IRS, he said.

“Most of the big fish” are disclosing their crypto transactions on tax returns “because they know they have a lot to lose” if they don’t, said Sean Ryan, chief technology officer of NODE40, a blockchain accounting and tax software company. Still, some aren’t putting details on their returns. “When you have millions of dollars on the line, sometimes people are willing to take on that risk.”

Those who got the gentler letters likely include parents of dependent high-school and college-age children who may have bought and sold crypto without their parents knowing or understanding how to report it, Moore said. Such people should file an amended return, she said.

Other taxpayers who got letters may occasionally dabble in Bitcoin and might not even owe any tax because they’re holding on to their virtual currency. The IRS requires taxpayers to report all crypto sales, even if no tax is owed because they produced a loss.

The IRS’s only real guidance came in 2014, when Bitcoin was in its infancy and trading at a fraction of its current value of about $10,000. IRS Commissioner Charles Rettig said in May that further guidelines would be coming soon. But in the meantime, investors and their tax advisers have had to make educated guesses about how to report income and pay taxes from virtual-currency transactions.

Bitcoin and other crypto assets aren’t currencies but property, the IRS said in 2014, and thus taxable at capital gains rates.

Whether you’re the investor or the tax accountant, tallying crypto tax bills is difficult. Virtual currencies operate on blockchain technology, which links computers to verify and record transactions. To calculate a taxable gain or loss, investors need the ledger of every transaction between a crypto asset’s purchase and sale date. Separately, the crypto industry has long trumpeted the values of decentralization and lack of government control, so some investors simply may not disclose their holdings.

The IRS occasionally has shown leniency if taxpayers voluntarily disclose that they’ve evaded taxes, including U.S. citizens who hid income in offshore accounts. That program has since ended and been replaced with a general voluntary disclosure program that’s not specific to cryptocurrency investors or offshore banks. However, the agency says it makes a practice of taking into account whether a delinquent taxpayer comes forward on their own accord when levying penalties and fines.

“Either you reported the income or you didn’t — there’s not really a way out, other than for a lawyer to potentially negotiate less prison time,” said Jason Tyra, a certified public accountant focused on cryptocurrency. “The IRS does not lose on this issue.”