By Thomas Franz
BridgeTower Media Newswires
DETROIT, MI — The Bitcoin craze that caught fire in the second half of 2017 has extended in 2018, and now questions are arising for how the IRS will view transactions involving cryptocurrencies this tax season.
Detroit-based Varnum LLP attorney Eric Nemeth said IRS data shows that more than 30,000 U.S. citizens have or are engaging in Bitcoin transactions, but less than 1,000 tax returns reflect Bitcoin activity.
“There seems to be a lot of confusion in the area of reporting. The IRS is taking a bit more sinister view of it,” Nemeth said. “The IRS has started a cybercrime unit specifically at cryptocurrency, and what they’re looking at in particular is how money comes into and out of the system.”
Nemeth said some features of obtaining cryptocurrency include anonymity and lack of transparency, but those characteristics go away when it’s time to report taxes.
“For the everyday person who’s interested in acquiring or holding Bitcoin or already has it and is looking at selling theirs, they need to understand that the government is looking to see these transactions on government tax returns,” Nemeth said.
Nemeth explained that the government recently won a John Doe summons enforcement case in the cryptocurrency space, and that follows a decade of offshore investigations that resulted in $10 billion in penalties and taxes relating to underreported accounts.
“From a detection standpoint, the IRS is taking the view right now that they will look for unexplained deposits coming to conventional accounts or money going to brokers. If you’re seeing a lot of money going to a known Bitcoin trader, then you don’t see any reporting of that on tax returns, that’s going to be an investigative tool,” Nemeth said.
As for enforcement, Nemeth said traditional laws mandating criminal sanctions for failure to report income would be used for cryptocurrencies.
“Those array of tools would apply to people who are engaged in cryptocurrency transactions, and they’re not reporting their information or they’re not accurately reporting. If it’s detected you made a million dollars trading cryptocurrency and that’s not on your tax returns, you’re facing an array of sanctions depending on the facts and circumstances of your case,” Nemeth said.
For advising tax clients, Nemeth said it’s important to get in cryptocurrency investors’ minds that this space should be no different from a brokerage or real estate account, and that investors simply need to file an accurate return.
“If you’re the one that they find, does it really matter they didn’t find nine other people who hid it and got out the door,” Nemeth said. “The temptation here is these currencies have been marketed in some ways that those things don’t exist. I think that’s going to be a challenge for professionals in this space is that to get clients to open up with you, much less figuring out the conventional tax treatment.”
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Cryptocurrency succession
Pamela Morgan, a cryptocurrency specialist with Empowered Law and founder of Third Key Solutions LLC, said another issue to discuss with cryptocurrency clients is key security, management and succession.
“These assets are secured with cryptography and accessed using something called a private key. Sometimes more than one private key secures an asset, and multiple keys must approve a transfer,” Morgan said.
Morgan said accessibility for the trustee or beneficiaries depends entirely on access to these keys, but tax lawyers or advisers should not hold a copy.
“The key material is highly sensitive, anyone who has it can move the funds without recourse. These assets are controlled by these keys alone, not by a third party. Think of them as gold or cash, except digital and gone with the slightest data breach,” Morgan said. “Any trustee must have key management experience and clear written processes for generating keys, storing these keys, and moving funds.”
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