Recent Development on Crypto Taxation

The extraordinary gain of crypto assets, especially virtual currencies, has brought forth the urgency and importance of US taxation.

In Notice 2014-21, the IRS describes crypto assets — which it calls 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,” other than a representation of the U.S. dollar or a foreign currency. The IRS declares, conclusively, that crypto assets are “property” for tax purposes and that taxpayers have gain or loss upon an exchange of crypto assets for other property.

As such, though intangible and trading as virtual currencies, cryptocurrencies are not currency per se but taxable assets. New to currency and securities regulators, crypto grow exponentially in recent years almost in a legal void-and IRS now tries to catch up and ramp up crypto asset taxation.

In Frequently Asked Questions (FAQs) on its website, the IRS discusses a number of instances where a taxpayer will recognize income or loss from a crypto asset transaction, including:

Selling crypto assets for real currency;
Providing services and receiving crypto assets as payment;
Crypto assets paid by an employer as remuneration for services constituting wages and compensation;
Exchanging crypto assets for other property or vice versa; and
Cryptocurrencies going through a “hard fork” followed by an “airdrop” when the taxpayer receives new cryptocurrency (see Chief Counsel Advice 202114020).

To identify crypto assets and taxpayers, IRS started with one of most successful crypto trading platform-Coinbase. In 2016, IRS served a so-called John Doe summons on Coinbase, in an attempt to identify the Coinbase customers who failed to report taxable income from the defined crypto asset transactions; subsequently with more specific and narrowed information request, a federal district court granted enforcement of the summons, requiring and compelling Coinbase to provide financial records of taxpayers having conducted any transactions via Coinbase platform in excess of $20,000.

In 2018-2019, IRS announced a crypto asset compliance campaign, and started sending letters to the identified crypto account holders. Also in or about April 2021, a Massachusetts court upheld a second John Doe summons against Circle Internet Financial, a crypto asset trading platform in Boston, and a third John Doe summons issued against Payward Ventures Inc. and subsidiaries d/b/a Kraken.

To catch up on tax evasions and under-reporting in crypto and virtual currency space, IRS established a new program titled “Operation Hidden Treasure.” Operation Hidden Treasure agents are specially trained in cryptocurrency and virtual currency tracking, with an enforcement focus on crypto trading income. Operation Hidden Treasure aims to root out tax evasions, search for and identify various “tax evasion signatures.” Signatures may include “structuring,” which means literally structuring transactions in increments of less than $10,000 to avoid certain reporting requirements, the use of “nominees, shell corps” or “getting on and off the chain.” The IRS also working with sophisticated vendors to identify and investigate these tax evasion signatures. The Operation Hidden Treasure agents also leverages crypto vendors/trading and exchange platforms, analyze blockchain and de-anonymize crypto transactions to track, find, and seize crypto for tax evasion.

The Biden Administration’s tax plan proposal will presumably increase resources to combat tax evasion relating to crypto assets. And, US Treasury’s Financial Crimes Enforcement Network (FinCEN) proposes to amend the regulations under the Bank Secrecy Act(BSA) to include crypto assets as a type of reportable account—which covers banks and money services businesses (but not necessarily crypto trading platforms such as Coinbase, Kraken, etc.) on their record-keeping, KYC, and FinCEN reporting obligations.

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