What is Operation Hidden Treasure? In early March 2021, the IRS has issued directives to address taxable transactions, sales, and exchanges regarding virtual currency in the upcoming tax years in an attempt to get ahead of individuals and businesses utilizing cryptocurrencies. More specifically, with this directive, the IRS is moving to identify individuals who own and regularly transact virtual currency within the scope of “tax evasion signatures” including “structuring” virtual currency transactions in increments of less than $10,000 to avoid certain income reporting requirements. According to numerous news articles released after the IRS public announcement, the IRS is actively (and has previously been) coordinating with sophisticated (third party) vendors to identify and subsequently investigate potential tax evasion signatures related to virtual currency and the potential unreported virtual currency transactions. Damon Rowe, the Director of the Office of Fraud Enforcement at the Internal Revenue Service, announced at a Federal Bar Association presentation on fraud enforcement priorities that the office has “added some crown jewels,” including a dedicated team of IRS Criminal Investigation professionals who are working on “Operation Hidden Treasure.” Operation Hidden Treasure is comprised of agents who are trained in cryptocurrency and virtual currency tracking, and who are focused on taxpayers who omit cryptocurrency income from their tax returns. Operation Hidden Treasure is a partnership between the civil (IRS) office of fraud enforcement and the IRS Criminal Investigation Unit to root out tax evasion from cryptocurrency owners.
So, what is virtual currency (VC) anyways?
In the simplest of terms, according to the IRS FAQ definition(s), virtual currency is “a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are “convertible,” which means that they have an equivalent value in real currency or act as a substitute for real currency. In summary, virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency, per IRS Rev. Rul. 2019-24. For reference, there is about 3,000 different, active cryptocurrencies and an estimate of more than 6,000 in total since 2018. Additionally, the IRS has issued more than 10,000 notification letters (Notice CP-2000) to individuals whom the Services has concluded did not report taxable virtual currency transactions since 2018. So the IRS knows if you have cryptocurrency! You can find the IRS FAQ’s regarding virtual currency here: https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions. Additional VC definitions and terms can be found on the IRS web-site link here: https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies.
What is a deemed taxable VC event?
- Convert Bitcoin to a flat sale.
- Exchange Bitcoin for another virtual currency.
- Make a purchase with Bitcoin or other virtual currency.
- Use Bitcoin to pay for goods and/or services.
Then you may have to report a taxable transaction on your federal tax return with ordinary and capital income or loss dependent on the type of transaction you undertake. For example, if you sell or exchange Bitcoin for another virtual currency, then you would report a capital gain or loss of Bitcoin on your Schedule D via Form 8949 to report that virtual currency transaction. Additionally, for example, if you use Bitcoin to pay for labor services or you receive virtual currency for payment for services rendered, then you would a taxable income event for receipt of that virtual currency subject to income and/or self-employment tax(es).
But what about nontaxable VC events?
Won’t we have some nontaxable transactions with virtual currencies? Yes. In summary, non- taxable events include but are not limited to the following: purchases of coin with fiat – any currency secured by a government, transferring fiat out of an exchange, moving coin(s) from one exchange to another exchange, and lastly, moving coin(s) from exchange to your electronic wallet, for example. Additionally, given IRS Revenue Ruling 2019-24, a taxpayer does not have gross income under Section 61 as a result of a “hard fork of a cryptocurrency” the taxpayer owns if the taxpayer does not receive units of a/the new cryptocurrency. Contrastingly, a taxpayer has gross income, ordinary in character, under Section 61 as a result of an “airdrop” of a new cryptocurrency following a “hard fork” if the taxpayer receives unites of (the) new cryptocurrency. A hard fork is when a new cryptocurrency is created on the cryptocurrency’s Blockchain effectively digitally splitting the cryptocurrency creating a new cryptocurrency. IRS Sec.61 summarizes “all gains or undeniable accessions to wealth, clearly realized, over which a taxpayer has complete dominion, are included in gross income, Comm. v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955); moreover, income is ordinary unless it is gain from the sale or exchange of a capital assets or a special rule applies. So, are you holding Bitcoin as an investment, a payment source or both? Answers to those questions should be asked because the reporting will change based on the answers.
Operation Hidden Treasure Finds Non-Filers
With this newly unveiled initiative, the IRS is actively working – and has been for years – towards finding, and identifying particular American taxpayers, more specifically non-filers, who they now know own, regularly transact, exchange and/or barter with virtual currency that are now deemed taxable transactions required to be reported by the IRS. Additionally, with this new IRS directive, the IRS is now more actively tracing cryptocurrency transactions in an attempt to identify American taxpayers who are omitting higher dollar crypto-related transactions based on improved virtual currency tracking diagnostics that may or may elicit taxable transactions resulting in additional income taxes to the Treasury. In all of this, the IRS, in my humble opinion, is clearly further attempting to identify a new taxpayer base involving taxable virtual currency transactions in an attempt to derive increased tax revenues into the Treasury.
Of note, as of April 2021, the IRS does not have a voluntary disclosure program for virtual currency nor does it appear the IRS is so inclined to initiate a voluntary disclosure program.
If you have involved yourself with any virtual currencies, transactions, purchases, sales, exchanges, etc. it is best practice to confer with your CPA, or tax return preparer and/or a local tax attorney whom may have a virtual currency team or specialist to further assist you with your virtual currency concerns. In response to this initiative announced, all American taxpayers should take reasonable, responsible steps in reporting virtual currency activity within their US federal income tax returns by checking the box “yes” regarding VC activity as well as report any sales, purchases, transactions, exchanges or bartering of VC to your CPA for tax year(s) in which those VC transactions, activity occurred. At this point, you would rather be on the right side of tax law just in case the IRS comes knocking at your door years from now. Next month, we will explore virtual currency mining and the related tax effects.