IRS Fail: Treasury Audit Says it Can’t Manage Virtual Currencies

In a recently released internal report of an audit conducted by the Treasury department of the IRS and its ability to properly ensure taxpayer compliance with regards to virtual currencies (VCs) such as Bitcoin, Deputy Inspector General for Audit Michael McKenney gave the IRS a big fat ‘F’.

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The three-part audit found that — in the prevailing three years since the Bank Secrecy Act (BSA) delegated the IRS responsibility for managing the use of VCs — it has not made any significant progress in developing a strategy to assess the risk of tax fraud using VCs. Nor has it done anything to give taxpayers more guidance on how to comply with tax laws regarding VCs.

IRS Made VC Tax Rules Confusing and Complicated

In March 2014, the IRS put out a public request for comments to Notice 2014-21. This notice basically stated that virtual currencies would be treated as property as far as taxes were concerned.

It complicated things for taxpayers, because tax laws regarding property specify that the fair market value of the asset be recorded at the time of a transaction, for the purposes of calculating gains/losses for income tax. This makes it pretty difficult for people who just use VCs to buy coffee, or something from an online shop.  Imagine having to keep track of every coffee purchase, its time, and then finding out what the BTC/USD price was in order to be able to do your taxes each year. As a result of its request for public comment, the IRS received 36 comments which we can summarize in three points:

The added complexity of record keeping due to lack of clarity on what valuation source to use for market price, and the onerous task of how such massive amounts of data people would need to keep for businesses that deal with virtual currencies on a daily basis, such as exchanges. How to keep track of funds earned by mining bitcoins.  Given pool mining technicalities, the time at which a payment share is dispersed to pool contributors would affect at what price the dividend payment is valued. Uncertainty on ensuring tax compliance for transactions using VCs. These include individual retirement or investments accounts and charitable donations, and determining what accounting method should be used in which cases (mark-to-market, book value, etc).

All of these are very valid public concerns.  However the IRS has given no further advice or guidance on any of these issues.

Clearer Definitions, New Forms Needed

In comparison, the Australian Tax Office (ATO) has addressed the need for such guidance by clearly differentiating the treatment of virtual currencies depending on their use. Both the ATO and the IRS both determined that VCs like bitcoin are assets subject to capital gains taxes. However the ATO decided there will be no income tax implications if a person is just using it to pay for goods or services, so long as the purchases are less than $10,000 AUD. This greatly simplifies the tax reporting burden for virtual currency users as a payment method.

Finally, the audit criticized the IRS’ lack of action in revising the necessary 3rd party tax forms employers use to report on your incomes or effect withholding. Currently, the forms do not have separate categories for income paid in virtual currencies versus regular dollars. Without such form revisions, the IRS will find it very difficult to gauge how much taxpayer income is being paid in VCs and thus how much of a non-compliance risk they are actually dealing with. Like the previous cases, the IRS blamed available information technology resources for its lack of progress.

IRS Lacks Resources to Properly Assess Virtual Currency Issues

In summary: the IRS, while given the mandate to monitor, assess compliance risk, and ensure compliance with tax laws regarding virtual currencies, seems to lack the needed resources to do so. In fact, until they start collecting more information on how much income is actually being paid in virtual currencies, they don’t even have an idea how much revenue loss they are potentially dealing with. Without this, it becomes hard to prioritize efforts. As with many other virtual currency issues, this is yet another chicken-and-egg problem. Until then, law-abiding people have to keep on guessing what the right way to pay the taxman should be.

What do you think about the report and current stance or lack thereof the IRS has on virtual currencies? Let us know in the comments below.

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