The IRS has several tools in its arsenal to encourage compliance and audit and enforce those it believes are failing to comply.  One of the most powerful tools is the John Doe summons. A regular IRS summons seeks information on a specific taxpayer.  However, a John Doe summons, as the name implies, involves a group of taxpayers that the IRS cannot identify by name – yet.  Judicial approval is required, but the approval is ex parte (i.e. opposing parties are not notified or can respond before the court rules).  The IRS has used this tool to find tax shelter participants by summonsing the promoters, and most famously foreign banks like UBS, for foreign bank account holders.  The next target, cryptocurrency investors.

The IRS already successfully received thousands of names of account holders from the Coinbase cryptocurrency exchange. Many taxpayers, who received letters from Coinbase about the disclosure, came forward and disclosed assets in their accounts.

The IRS has now secured permission to issue a John Doe summons for cryptocurrency records on payments using a technology company called Circle and another popular cryptocurrency exchange – Kraken. This is all part of what the IRS has called, in public speeches, a “treasure hunt” for unreported cryptocurrency. If you have unreported cryptocurrency transactions, here’s what you should know.

Failure to Report Can be Criminal

The IRS has indicated on several occasions that it is aware that millions of cryptocurrency transactions may still remain unreported. The best way to avoid penalties is to disclose and report as accurately as you can, showing that you did not have a willful intent to avoid paying taxes. Taxpayers may think that the IRS may penalize them, but they might assume that they need not worry about any criminal implications.  Unfortunately, this is not true.  The IRS, as part of its crackdown on cryptocurrency, is increasing its criminal investigations.  If convicted of tax evasion, you could face up to five years in prison and a fine as high as $250,000. The IRS has made willful failures easier for them to prove by moving the question about cryptocurrency transactions to the front of the individual tax return (Form 1040) so it is as conspicuous as possible.

Limited Guidance by the IRS

The first official IRS guidance on cryptocurrency wasn’t released until 2014 (Notice 2014-21) indicating that the IRS would treat cryptocurrency as property for tax purposes. Since that time the guidance has been scant and, when issued, is often done in informal ways like FAQs on the IRS website. Although helpful, FAQs do not have the force of law and can be removed by the IRS without warning. If relying on a specific FAQ, it is good practice to print it in hard copy so you have the authority you used if the IRS decides to take that FAQ off the website. The hard questions about valuing and reporting cryptocurrency, for the time being, require an analysis of the current guidance and a thorough understanding of the law related to other forms of property. If unsure about cryptocurrency questions, a qualified tax advisor should be consulted.

Consider Voluntary Disclosure

If a taxpayer has significant unreported cryptocurrency holdings, a voluntary disclosure is a good option.  Criminal exposure can be limited by following the required steps and, in some cases, a streamlined voluntary disclosure might be warranted and comes with less severe penalties. The IRS has not set up a specific voluntary disclosure program for cryptocurrency; however, this may happen in the future, but the standard voluntary disclosure program is still available.

Photo of Joshua Smeltzer Joshua Smeltzer

Joshua Smeltzer is a tax litigator defending clients in tax audits, tax appeals, and litigation in Federal District Court, U.S. Tax Court, the U.S. Court of Federal Claims, and tax issues in U.S. Bankruptcy Court. Joshua’s previous work as a litigator for the…

Joshua Smeltzer is a tax litigator defending clients in tax audits, tax appeals, and litigation in Federal District Court, U.S. Tax Court, the U.S. Court of Federal Claims, and tax issues in U.S. Bankruptcy Court. Joshua’s previous work as a litigator for the U.S. Department of Justice provides him with first-hand knowledge of how government lawyers build and litigate tax cases.