The IRS Desperately Needs to Update Its Crypto Tax Guidance

Tax Day has come and gone, thank goodness. It’s never been my favorite time of year. But as a cryptocurrency holder, I’ve found the stress and annoyance of tax season has given way to utter bewilderment and rage.

The U.S. tax code desperately needs a makeover. The guidance on paying taxes on cryptocurrency gains or losses is absurdly lacking.

The IRS first recognized the need for guidance on “virtual property” and “virtual currencies” in 2008. Cryptocurrencies like bitcoin didn’t exist yet. But video games like World of Warcraft had 2.5 million subscribers in North America.

The world of digital currencies and property grew exponentially over the next 10 years. Yet, over the past decade, the IRS has issued just one additional piece of guidance regarding digital assets.

Published in early 2014, IRS Notice 2014-21, Virtual Currency Guidance, defined “virtual currency” as “a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value… [that] does not have legal tender status in any jurisdiction.” And it defined “convertible” virtual currency to be a virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.” The guidance also included some murky guidelines for taxing convertible virtual currencies.

In 2016, the Treasury Inspector General for Tax Administration recommended that the IRS “take action to provide updated guidance.” But instead of following the Treasury’s advice, the IRS adopted a more aggressive enforcement stance.

Yet what exactly it’s supposed to be enforcing remains a mystery.

Later that year, for example, the IRS tried serving a “John Doe summons” on Coinbase, a large cryptocurrency exchange based in San Francisco. It directed the exchange to produce records identifying all U.S. taxpayers who had used its services at any point in 2013, 2014 or 2015, as well as documentation of those taxpayers’ virtual currency transactions.

Coinbase refused, noting that the request would cover millions of consumer accounts and that “asking for detailed transaction information on so many people, simply for using digital currency, is a violation of their privacy.” It was absolutely the correct response.

In March 2018, the IRS published a news release reminding taxpayers to report virtual currency transactions:

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited… [and] liable for penalties and interest. In more extreme situations, taxpayers could be subject to criminal prosecution…

Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

This is absurd. People don’t understand IRS rules on cryptocurrency because it wasn’t explained very well back in 2014. I don’t know the difference between “virtual currency” and “convertible virtual currency.” I have a couple of ideas. But who knows if the IRS agrees with me?

Here’s an example: The IRS clearly says that a virtual currency “does not have legal tender status in any jurisdiction.” So, what happens if Japan or Malta confers legal tender status on bitcoin? Which rules are bitcoin subject to as stated in the IRS’ Virtual Currency Guidance?

And while the IRS threatens penalties and prison time for tax evasion, it makes getting tax relief virtually impossible. The “tax lot relief” method determines which lot of stock or securities – and its associated cost basis – is used in computing the gain or loss on a sale… and whether that gain or loss is long or short term.

A Coin Center Report published this month says the only possible method for virtual currency holders would be specific identification, requiring a convoluted series of actions…

Taxpayers need to, for each unit of virtual currency they possess, keep track of the date on which they acquired that virtual currency as well as their adjusted basis in it. Then, every time the taxpayer transacts with virtual currency, they must identify the specific unit of virtual currency with which they are transacting and use that specific unit’s adjusted basis, alongside its fair market value at the time or day of the transaction, to determine their gain or loss.

Further, if the gain or loss is a capital gain or loss, then the taxpayer will need to compare the date on which they acquired that specific unit of virtual currency with the transaction date to determine whether their capital gain or loss is short term or long term.

This is profoundly ridiculous. There has to be a better way.

But instead of rationalizing or, at the very least, explaining its rules, the IRS is ramping up enforcement that could turn thousands of taxpayers into unintentional tax cheats.

It’s a new tax year. April 15 is in the rearview mirror. It’s time for the IRS to rectify this absurd situation and provide clarity on such basic tax issues as determining the “fair market value” of cryptocurrency.

Some members of Congress agree with me. Last week, 21 members sent a letter asking the agency to issue needed guidance for taxpayers who use virtual currencies.

Will the IRS listen? Probably not. It’s the fourth letter Congress has sent to the IRS about this issue.

The IRS excels at turning a blind eye to serious issues. So a louder, more widespread public outcry is needed to force its hand. I strongly encourage you to write your congressman or congresswoman and let them know that the IRS turning cryptocurrency holders into the enemy because of its deeply flawed guidance is unacceptable. Increased enforcement is not the answer. Fix the rules.