In a petition filed November 17, 2016 with the U.S. District Court for the Northern District of California, the U.S. Department of Justice (DOJ) asked the court for a John Doe summons to be issued on bitcoin exchanger Coinbase Inc.
The John Doe summons would require Coinbase Inc., the largest bitcoin exchanger in the U.S., to provide the DOJ with information related to all bitcoin transactions it processed between 2013 and 2015. The DOJ would then share the information received with the Internal Revenue Service to be matched against filed tax returns. The IRS would be looking for bitcoin transactions that have the potential for successful criminal investigation and prosecution.
The IRS has previously stated a position that virtual currency transactions, such as bitcoin, are property on which gain can be realized. In Notice 2014-21, the IRS stated that it would tax digital money such as bitcoin like property, not currency. The IRS also believes bitcoin transactions provide an opportunity for tax evasion. In fact, according to the IRS, the potential for tax evasion is enhanced via bitcoin transactions, “because there is no third-party reporting of virtual currency transactions for tax purposes … and the likelihood of under-reporting is significant.”
Although IRS Notice 2014-21 did not address whether bitcoins would be considered an approved investment for retirement purposes, the fact that the Notice is treating bitcoins as property, like stock, and not as a collectible, it should be clear bitcoin is an approved investment for IRAs and 401(k) plans and would not violate IRC 408(m). If bitcoins were purchased using retirement funds, such as a self-directed IRA or Solo 401(k) plan there would generally be no tax on the gains from the purchase or sale of bitcoins. The tax ramifications of purchasing bitcoins with retirement funds could get somewhat complex, especially if the retirement account investor is considered to be in the active business of trading bitcoins, which could generate a tax called the Unrelated Business Taxable Income tax (UBTI), which can go as high as 40%.
Anyone engaging in bitcoin transactions, particularly those transactions utilizing the exchange services of Coinbase Inc. during the 2013 to 2015 time frame, should take note of the DOJ summons.
If there are any bitcoin transactions that may be of concern, now is the time to consult with a tax professional and consider all your options, including voluntary disclosure.
Investing in bitcoins is perfectly legal, however, there are income tax implications for buying and selling bitcoins, which many taxpayers seem to be unaware of. Using a self-directed IRA or Solo 401(k) plan to buy bitcoins could prove to be highly tax efficient, especially in light of the IRS’s recent scrutiny into bitcoin investments.