Phil Karter, a former Department of Justice Tax Division trial attorney , is currently a partner within the Philadelphia Office of Chamberlain Hrdlicka. Kevin F. Sweeney, a former federal tax prosecutor, may be a senior counsel within the same office.
The following article is an exclusive contribution to CoinDesk’s Crypto and Taxes 2018 series.
On February 23, Coinbase, a well-liked U.S.-based digital currency exchange, notified 13,000 of its customers that it might be turning over their account information to the IRS. The notice was precipitated by a U.S. District Court ruling during a protracted John Doe Summons battle between the corporate and therefore the IRS concerning accounts with potentially unreported cryptocurrency income.
Ultimately, the Court found that the IRS was entitled to the knowledge .
The Coinbase summons battle is like aggressive tax enforcement efforts pursued by the Department of Justice to ferret U.S. taxpayers holding unreported income and assets abroad. That initiative also began with the issuance of a John Doe summons, but to a Swiss bank, UBS, for unreported foreign account information.
The IRS and DOJ then quickly expanded to other foreign banks and other countries. With the offshore voluntary disclosure program (“OVDP”) winding down, there are strong indications that the IRS are going to be turning its attention to unreported cryptocurrency transactions.
The overwhelming majority of people with unreported cryptocurrency income have options available to mitigate and defend against civil penalties and prosecution .
For those that received a Coinbase letter, the choices are more limited; most are going to be audited and a few will inevitably face the more drastic repercussions of a criminal investigation and prosecution.
Nonetheless, everyone with unreported cryptocurrency income must understand all the potential ramifications of their situation. Only then can they analyze and take appropriate action to form the foremost of a potentially bad situation.
Who is most at risk?
Although U.S. tax laws ostensibly operate a system of “voluntary compliance,” the IRS and DOJ routinely seek to discourage minimization or evasion and coerce “voluntary compliance” by making samples of some non-compliant taxpayers.
For those that find themselves therein position, the danger of criminal investigation and prosecution is real.
Consequently, before taxpayers and their advisors choose the way to remediate and/or defend cryptocurrency related compliance issues, it’s important to acknowledge where a specific taxpayer falls on the spectrum of civil versus criminal exposure.
The following categories of people with unreported cryptocurrency income should take particular caution:
Individuals who bought cryptocurrency with the proceeds of unlawful activities;
Individuals who accepted or converted other sorts of currency into cryptocurrency to hide income or assets from the IRS;
Individuals with substantial unreported cryptocurrency income and/or gains;
Individuals who derive all or most of their income from cryptocurrency (e.g., bitcoin miners); and
Individuals who will still stick their head within the sand and fail to bring their unreported cryptocurrency into tax compliance, as some unreported foreign accountholders still do.
How to defend a case?
As a preliminary matter, taxpayers and their advisors must avoid taking any action with the IRS until they need fully analyzed all of the civil and criminal risks.
The best practice is for an attorney with criminal tax experience to conduct this analysis either alone or with the help of an accountant under what’s referred to as a Kovel arrangement (in which the accountant acts as a sort of subcontractor to your lawyer and thus communications with the previous are covered by attorney-client privilege). this may allow the tax advisors to find out the facts necessary to advise the taxpayer while protecting any sensitive communications.
If there’s little to no criminal exposure, the taxpayer should consider filing a professional tax return (QAR). Besides correcting the cryptocurrency reporting, the filing of a QAR has the additional advantage of assisting taxpayers to avoid accuracy related penalties. However, anyone who is under audit or criminal investigation or is that the subject of a John Doe Summons, like the one issued to Coinbase, is precluded from filing a QAR.
Even if a taxpayer is disqualified from filing a QAR, he or she should be ready to avoid penalties by filing an tax return and establishing reasonable cause for noncompliance. But they ought to not do so lightly.
An inaccurate tax return is probably going to extend , instead of decrease, one’s criminal exposure. In many cases, cryptocurrency exchanges have gone out of business, leaving taxpayers with a logistical records nightmare.
Although it’s going to be theoretically possible to accurately trace transaction history through the blockchain ledger, such a process is beyond the sophistication level of most. At an equivalent time, if a taxpayer guesstimates transaction data, or if his or her plan to reconstruct records differently goes awry, the IRS may perceive these inaccuracies to be intentionally false items.
If a taxpayer’s criminal exposure is critical , he or she should seriously consider entering the domestic or offshore voluntary disclosure program, counting on where and the way the unreported cryptocurrency was held. This approach isn’t likely to supply penalty relief but does offer a chance to avoid the more severe consequences of prosecution .
For those that don’t qualify for a voluntary disclosure program or find themselves under criminal investigation or a sensitive civil audit headed that direction, fewer options are available. In these cases, the main target must shift from the way to correct prior tax filings to protecting against a criminal conviction.
The government’s success in prosecuting tax related cryptocurrency cases will likely come right down to its ability to spot and acquire records about taxpayers’ cryptocurrency holdings also as evidence that their noncompliance was willful.
By responding to an IRS summons or subpoena for records or testimony, a taxpayer could assist the govt in proving both. Consequently, it’s important for taxpayers to proactively consult experienced criminal tax counsel as soon as he or she receives notice of a criminal investigation or audit or has reason to believe one is imminent.
In some circumstances, that attorney may advise the taxpayer to say his or her Fifth Amendment privilege against self-incrimination instead of providing the requested testimony or records.