The US Government is Worried that Usage of Digital Currencies will Lead to Tax Avoidance

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The Treasury Inspector General for Tax Administration (TIGTA) published a document this fall that reviewed the growing usage of Bitcoin and other digital currencies in the private sector. While acknowledging there are benefits to “virtual currencies” including lower transaction fees and faster transfer of funds for services provided, the government is deeply concerned that virtual currencies are also popular because the identity of the parties involved may be anonymous, leading to a greater possibility of their use in illegal transactions.

bitcoin-2Back in 2014, the Internal Revenue Service made the determination that virtual currencies are “property” – a way for the government to differentiate between a fiat currency issued by a government and currency created by another entity and establish a tax approach. But this also creates an enigma for the Feds regarding individuals seeking to skirt their monitoring responsibilities as digital currencies have the ability to do just that.

Banks, the traditional transaction middle-man for financial transfers, are highly regulated entities. Bitcoin transactions which occur in a distributed environment are not. The government has established highly regulated reporting obligations upon financial institutions and money services businesses or MSBs. These MSBs are money transmitters, currency dealers, issuers of traveler’s checks, money orders etc. who are required to register with FinCEN) At one point the US Department of Treasury via FinCEN issued guidance that states a user who obtains virtual currency and uses it to purchase real or virtual goods or services is not an MSB thus no reporting is necessary.

Pointing to the success, and ultimate downfall of Ross Ulbricht and his Silk Road site, the government fears the anonymity feature of virtual currencies and the unscrupulous characters it may attract. With this in mind, they are recommending the IRS to prepare a comprehensive strategy that will “assist taxpayers” lawfully engaged with virtual currencies to voluntarily comply with the tax laws while seeking to identify individuals unlawfully engaged in their use.

The complexity of the challenge is exemplified in the government’s explanation of what they expect should occur in using Bitcoin or another digital currency in a transaction:

“if a taxpayer uses a portion of a bitcoin to buy a cup of coffee each day for one week, he or she will have to determine what portion of the bitcoin was used to make the purchase based on the daily exchange rate, convert it into U.S. dollars, and keep a record of each transaction so that the gain or loss from his or her virtual currency property can be properly reported.”

Right.

Treasury warns that until a strategy is developed regarding digital currencies, the “IRS is open to the risk that undetected noncompliance of virtual currency taxable transactions…”

The document by TIGTA itemizes three recommendations including;

  • The development of a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation. This recommendations was accompanied by a demand to educate taxpayers on digital currency compliance.
  • Action by the IRS should be taken to provide guidance to reflect the documentation requirements and tax treatments needed for the various uses of virtual currencies. This would “help” taxpayers voluntarily comply with their tax obligations.
  • There is a need to revise third-party information reporting documents to identify the amounts of virtual currency used in taxable transactions.

taxes-single-taxOf course involving the government in Bitcoin/Crypto currency transactions means added layers of compliance and cost that has the potential to undermine some of the aforementioned benefits of digital currencies. The IRS should probably exempt individual transactions below a specific transaction value as not requiring any additional reporting. The bigger problem is that the proposed approach adds layers to an already byzantine and productivity killing tax regime in the US. Obviously this is a far bigger problem and virtual currency taxation is just a symptom of the illness. It is a tall task for a federal agency to think outside of their mandated objectives.

The document, embedded below, is perhaps more indicative of a government struggling with formulating a tax policy using an approach better suited for time before Bitcoin. With Congress expected to tackle tax reform in 2017 adding virtual currency to the legislative list may be the better approach.


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