On September 24, 2020, the TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION (TIGTA) issued a final audit report: “The Internal Revenue Service Can Improve Taxpayer Compliance for Virtual Currency Transactions” that evaluates the IRS’s efforts to ensure accurate reporting of virtual currency transactions as required under U.S. Code Title 26 (Internal Revenue Code) and Title 31 (Money and Finance).
TIGTA initiated the audit because the use of Virtual Currency (VC) as a payment method continues to grow in popularity that seems to be emerging as an alternative to U.S. or other fiat currencies. The audit focused on VC exchanges. VC exchanges play an important role in the transferability and stability of VC through facilitating the buying and selling of assets for customers. Under U.S. Code Titles 26 (Internal Revenue Code) and 31 (Money and Finance), the IRS is expected to monitor and to require the accurate reporting of virtual currency transactions. The TIGTA audit report conducted by TIGTA suggested that the IRS has further work to do.
The sale or exchange of VC has an impact on Taxpayers
The sale or exchange of VC, the use of VC to pay for goods or services and holding VC as an investment have tax outcomes that could result in tax liability. Taxpayers who do not accurately report VC transactions on their U.S individual income tax returns face liability for related income, penalties, and interest. IRS reviews the VC Exchanges – which engage in the business of exchanging VC for fiat currency or other VC. The VC exchanges “ought to be able to provide important taxpayer information for IRS use”, but the audit report found that the information reporting on VC transactions from the VC Exchanges is lacking.
To be compliant, Taxpayers should understand that under Internal Revenue Regulations, tax principles applicable to property transactions likewise apply to VC transactions:
- A payment made using VC is subject to information reporting in the same way as any other payment made using property.
- A payment made to independent contractors and other service providers using VC is taxable, and self-employment tax rules apply. The “Payer” must issue Form 1099-MISC (Miscellaneous Income).
- Wages paid to an employee using VC are taxable to the employee and must be reported by an employer on a Form W-2 (Wage and Tax Statement). These wages are subject to Federal income tax withholding and payroll taxes.
- Since VC may be used to pay for goods or services, the third parties who settle payments made in VC on behalf of merchants that accept VC from their customers are required to report payments to those merchants on Form 1099-K (Payment Card and Third Party Network Transactions).
- A gain or loss from the sale or exchange of VC depends on whether the VC is a capital asset in the hands of the taxpayer.
VC as a payment method continues to be popular
While VC as a payment method is popular because it allows users to pay lower transaction fees and achieve faster transfer of funds, its use permits “pseudo-anonymity” in transactions and the possibility of avoiding tax reporting obligations. Accordingly, there are U.S. tax compliance risks arising from willful conduct by a taxpayer (evading taxes) or non-willful conduct (non-understanding of the tax implications of VC transactions, including the calculation of gain/loss from VC transactions, characterization of income, third-party reporting responsibilities).
IRS is working to develop guidance for third-party reporting and in a process to use and monitor Title 31 VC information in the Title 26 examination workload
IRS is focused on improving the information reporting platform by requiring all VC Exchanges to report all VC transactions to the IRS. On July 2020, the IRS stated that all FinCEN (Title 31) data was made available in its Compliance Data Warehouse, which is accessible to the Title 26 program. IRS will continue to try to close the VC information gap and Taxpayers need to be prepared. Who is your VC specialist? ©