ERIC ROSS CPA
The Recent IRS Court Ruling versus Coinbase
The Court has issued a ruling in the battle between the Internal Revenue Service (IRS) and Coinbase, a company which facilitates transactions of digital currencies like Bitcoin and Ethereum, to determine whether the IRS is entitled to customer data. Today, the Court granted in part and denied in part the federal government's petition to enforce the hotly contested summons: in other words, the IRS may legally investigate Coinbase account holders who may not have paid federal taxes on their virtual currency profits, but the scope of the summons has been dramatically narrowed.
The case began in November of 2016 with a request filed on behalf of the IRS to serve a "John Doe" summons on all U.S. Coinbase customers who transferred Bitcoin, a convertible virtual currency, from 2013 to 2015. A "John Doe" summons is an order that does not specifically identify the person but rather identifies a person or ascertainable group or class by their activities. The IRS argued that the "John Doe" summons was necessary because they had found evidence of noncompliance and underreporting among Coinbase customers - the agency just couldn't identify the exact identities and scale of the problem without more information. The IRS was initially seeking all records, including third party information, related to Bitcoin transactions conducted by U.S. Coinbase customers over the 2013 to 2015 time period.
The initial request was granted and in response, Coinbase customer and attorney Jeffrey K. Berns, the Managing Partner of Berns Weiss LLP, filed a motion to intervene and have the ruling set aside. The IRS responded with a motion asking the court to deny Berns the right to intervene. Eventually, Berns withdrew his motion and in March of 2017, the IRS filed a new action seeking to enforce the summons on Coinbase. Coinbase also argued against the summons as did several "John Does."
In its defense of the subpoena, the IRS argued that:
There has been an explosion of billions of dollars of wealth in just a few years from bitcoin, a significant amount of which has no doubt accrued to United States taxpayers, with virtually no third-party reporting to the IRS of that increase in income.
The IRS also scoffed at the argument that "Bitcoin and blockchain are high regulated technologies," comparing it to "barter exchanges in the 'Wild West' days of the late 1970s and early 1980s, before Congress imposed reporting requirements on these barter exchanges." Further, the IRS argued that some users of cryptocurrency "have openly acknowledged they consider using bitcoin in order to avoid tax reporting requirements."
Even as they argued that such a broad request was necessary, the IRS agreed to narrow the scope of the summons. The IRS also agreed not to seek records for users for which Coinbase filed forms 1099-K during the time period in question or for users whose identity is known to the IRS.
After the scope was narrowed, the IRS argued that Coinbase admitted that the targeted information still involved 8.9 million Coinbase transactions and 14,355 Coinbase account holders. However, according to the tax agency, "only 800 to 900 taxpayers reported gains related to bitcoin in each of the relevant years and that more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin in a given year." That suggested "that many Coinbase users may not be reporting their bitcoin gains." The IRS, the court found, "has a legitimate interest in investigating these taxpayers".
The IRS has determined that bitcoin will be considered property, not a currency. For most investors, particularly those who have been in the bitcoin game for a long time, this is a favorable ruling; accrued long-term gains and losses will be taxed at each investor’s applicable capital gains rate (15% or 20% max) as opposed to at ordinary income rates . Bitcoin miners and investors may see a huge difference in marginal rates as a result of this distinction. Nonetheless, active traders with short-term capital gains could still be taxed at their ordinary income-based rates, so it’s a good idea to consult with a tax professional at Eric Ross CPA.
The fact that bitcoin is property and not a currency makes losses that much more difficult to write off, on the other hand. For the IRS, net capital losses are capped at $3,000 per year for married and single filers on personal tax returns. This means that large short-term trading losses may have to be carried forward for years. This places investors who have suffered trading losses in a disadvantageous position compared to what they would have been able to write off with “foreign currency” losses against ordinary income.
However, there is a solution for active bitcoin or digital currency traders who face losses above $ 3,000 from trading. Caution and planning are necessary in that little can be done to recognize losses above the capital loss limitation if proper elections are not made timely or if the trading is transacted in individual names rather than through an entity.
Call us at 914-479-7730 and we can discuss alternative tax planning solutions
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