Cryptocurrency holders are receiving extra scrutiny from the Internal Revenue Service (IRS) as the bureau begins to crackdown on individuals who have been non-compliant. The IRS recently issued letters to more than 10,000 Bitcoin and cryptocurrency holders, detailing the penalties for failing to pay tax on cryptocurrency transactions.
What Does the IRS Letter Mean?
The letter, known as Letter 6174-A, is a warning to cryptocurrency holders who have not accurately reported their cryptocurrency income. Individuals who have not been compliant must file amended or delinquent tax returns on their virtual currency transactions, labeled “Letter 6174” at the top of the return prior to mailing them to a special address. Failure to do so can result in the IRS taking actions of civil and criminal enforcement.
The IRS website has asked individuals who are compliant in their crypto transactions to sign a statement declaring compliancy, according to a recent Wall Street Journal article. IRS Commissioner Chuck Rettig said that, “Taxpayers should take these letters very seriously,” as the IRS will continue to expand its efforts on cryptocurrency compliancy with “increased use of data analytics.”
It is not certain how much the IRS knows on the individual cryptocurrency holders, however Coinbase, a leading digital currency exchange headquartered in San Franciso, California was summoned by the IRS to release information on all of their account holders. It’s speculated that other exchanges have also provided information, but the IRS has declined to say whether the letters are a result of that information.
Cause for Concern?
In the letters, the IRS informs recipients on why they have received the letter, and steps they must take whether they are compliant or have not filed for one or more taxable years. According to a Forbes article, crypto tax attorney Tyson Cross says it is unlikely that recipients of these letter were personally targeted, but rather a generic mailing campaign.
Nevertheless, the letters can be seen as proof that the IRS will become more aggressive in their push for accurate reporting among cryptocurrency holders. Furthermore, individuals with larger transactions have a greater risk of being audited.
The Taxation of Cryptocurrency
From a federal and tax standpoint, cryptocurrency is treated as property by the IRS for U.S. federal tax purposes. As a result, the same tax principles that apply to property also apply to cryptocurrency. This means that all income or gains from the sale of cryptocurrency will be treated like a capital asset. It will be subject to short-term (ordinary income tax rates) and long-term capital gains tax rates (15% or 20% based on income).
Self-Directed Cryptocurrency Investments
One of the benefits of using a retirement plan to make investments is that investors can defer tax on the income/gains to a later date. Investors who have established a Roth IRA for investments can completely eliminate taxes on the investment returns. As a result, they do not have to worry about the IRS coming after them for unpaid taxes.
In order to invest in cryptocurrency and other alternative investments (real estate, tax liens, precious metals, etc.) the investor must first establish a Self-Directed IRA or in the case of self-employed individuals and small business owners, the Solo 401(k). Generally, banks and financial institutions limit investors to purchase the traditional assets they sell, which includes bank CDs, stocks, bonds, ETFs, mutual funds, etc., but not alternative investments. Whereas s Self-Directed IRA custodian allows investors to make both traditional and non-traditional (alternative asset) investments.
Bitcoin and Other Crypto on the Rise
With the rise of Bitcoin and other cryptocurrency, as well as Facebook’s very own crypto coin, Libra, cryptocurrency is once again becoming a lucrative investment. However, it is important to note that cryptocurrency is extremely volatile, which makes it a risky investment. Any investor who chooses to invest in digital currency should be in a financial position to take a potential hit if the crypto market drops.
At IRA Financial, we do not offer financial advice or tell our clients what types of investments to make, such as Bitcoin and other cryptocurrency. However, our certified tax specialists will be available to help you avoid triggering a prohibited transaction with your self-directed retirement plan. For assistance, contact us directly at 800-472-0646.