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Taxpayers With Unreported Cryptocurrency Gains Should Start Thinking About Filing Qualified Amended Returns – And Soon

In a high profile summons enforcement case brought by the Internal Revenue Service against Coinbase, Inc. (United States v. Coinbase Inc., No. 3:17-cv-01431 (N.D. Cal. 2017)), a virtual currency exchange for traders of popular digital cryptocurrencies like Bitcoin, Ethereum and Litecoin, the Internal Revenue Service sought the production by Coinbase of all of its customer records involving Bitcoin transactions from 2013 through 2015.  The number of customers potentially susceptible to such a broad summons request was estimated at just under 500,000.

The U.S. District Court for the Northern District of California considering the case ruled that the summons was overbroad but enforced a narrowed IRS request for Coinbase to turn over information about all accounts not already known to the IRS having at least one transaction of $20,000 or more in any year. As reported in the February 27, 2018 edition of Tax Notes, and on Coinbase’s own website, the company has notified about 13,000 customers determined to be subject to the summons enforcement order that it is turning over their identifying information and historical transaction records to the IRS for the 2013-2015 years.

The summons request was precipitated by the IRS’s belief that the vast majority of cryptocurrency traders have not been reporting their gains on their tax returns.  As reflected in the District Court’s summons enforcement order, the IRS determined that only 800 to 900 taxpayers had filed Form 8949s with their returns reporting the gains from the sale or disposition of cryptocurrencies.  Thus, the unreported income concerns of the IRS appear to have borne out by the summons enforcement proceedings.

Generally speaking, Coinbase customers (as well as customers of other cryptocurrency exchanges) that are not among the account-holders whose information is being turned over to the IRS as a result of the summons enforcement should take note that a warning shot has been fired across the bow.  If such persons have not reported cryptocurrency gains on previously filed returns, they should take little comfort in not being among those first 13,000 individuals identified by Coinbase.  Given the IRS’ increasing focus on cryptocurrency tax reporting, it is reasonable to assume that the IRS is not necessarily satisfied with letting sleeping dogs lie.  If a taxpayer is audited for unreported gains, adjustments are sure to follow, along with 20% accuracy-related tax penalties based on the underpayment of tax.

Is there an escape hatch to mitigate the risk of these tax penalties?  One to consider is the Qualified Amended Return or “QAR”  – that is if you have not already been contacted by the IRS.  A qualified amended return for individuals finding themselves in this situation is an amended return filed after the due date of the return for the taxable year (taking into account extensions of time to file) but before the taxpayer is first contacted by the IRS concerning an examination (including a criminal investigation) with respect to the return.  To the extent a QAR reports gains omitted from the original return, such gains are excluded from the deficiency calculation on which accuracy-related penalties are based.

Unfortunately, the 13,000 Coinbase customers whose information is being turned over to the IRS may not be able to rely on the QAR to avoid tax penalties.  That’s because the summons issued to Coinbase was what is known as a “John Doe” summons (a summons which does not identify the person with respect to whose liability the summons is issued, but is rather issued to obtain information about taxpayers unknown to the IRS), and such summonses are excepted from the penalty relief that QARs can provide to taxpayers who have yet to be contacted by the IRS.

This doesn’t necessarily mean that the unlucky 13,000 ostensibly the subjects of the John Doe summons enforced against Coinbase should do nothing.  There may still be mileage in voluntarily coming forward with corrected returns before the IRS comes calling.

One final word of caution.  An amended return does not qualify as a QAR if the amount reported thereon is a correction of a fraudulent position taken on the original return.  In such a case, a 75% fraud penalty may still be asserted against the taxpayer and, to make matters worse, the case could also be the subject of a referral for criminal prosecution.  As for the distinction between an unreported transaction subject to the 20% accuracy related penalty and a potential 75% fraud penalty or worse, that is a discussion for another day.  Suffice it to say the larger the amounts of the unreported gains and the greater the frequency of such transactions, the more interesting the fraud penalty or criminal referral is likely to look to the IRS.

  • Philip  Karter

    Philip Karter specializes in tax controversy and tax litigation matters.  In his 40-year career, Mr. Karter has litigated Federal tax cases in the United States District Courts, the United States Tax Court and the United States Court ...