In the wake of the success of its “Swiss Bank Program,” the U.S. Department of Justice (“DOJ”) Tax Division and the Internal Revenue Service (“IRS”) Criminal Investigation Division are gearing up for a similar initiative aimed at taxpayers using virtual currency to evade taxes. In public statements, key officials at the DOJ and IRS have made no secret of their intention to crack down on the use of cryptocurrency to evade taxes. They also appear to be following the same blueprint they used successfully in prosecuting taxpayers using offshore accounts. If history repeats itself, it is likely they will prosecute those who facilitate or in any way assist taxpayers in these efforts.
Swiss Bank Program Resulted in Billions in Fines and Settlements with over 80 Swiss Banks
In 2008, the IRS started the Swiss Bank Program by issuing John Doe subpoenas1 to Swiss banks to uncover then-unknown tax evaders. Following this initial step, the DOJ and IRS utilized further investigative tools, such as treaty requests and subsequent subpoenas, enabling the prosecution of individuals and, ultimately, the investigation of and settlements with financial institutions in Switzerland. In exchange for non-prosecution agreements and monetary penalties, Swiss banks disclosed their cross-border activities and provided information about U.S. taxpayer accounts and other banks into which individuals transferred funds. Over 80 Swiss banks cooperated in civil and criminal proceedings, and penalties exceeding $1.36 billion were collected. This was an unprecedented success for the DOJ and IRS in their long-running efforts to address an area of significant noncompliance that was thought by many to be an undetectable means to evade taxes.
The Offshore Voluntary Disclosure Program (“OVDP”) played a significant part in the IRS’s efforts to attack offshore tax evasion by encouraging and enabling taxpayers to come forward and disclose their offshore tax liabilities in exchange for the guarantee of non-prosecution. The OVDP resulted in over 54,000 self-disclosures and collected more than eight billion dollars in taxes and penalties. This program also led to the discovery of much useful intelligence, as each participant was required to provide information regarding the banks used and the individuals involved. This information then was available to the government in its prosecution of the financial institutions.
Upon the conclusion of the Swiss Bank Program in 2016, the then-Principal Deputy Assistant Attorney General warned that the Tax Division remained committed to holding individual taxpayers accountable for their respective roles in concealing foreign accounts and assets and evading U.S. tax obligations. At numerous conferences since, the DOJ has made clear that
it intends to replicate this enforcement formula in other parts of the world, as it tracks funds transferred out of the Swiss banks.
The IRS and DOJ Are Targeting Cryptocurrency Transactions
There currently exists a perceived anonymity for virtual currency transactions similar to that which existed for transactions in offshore accounts before the Swiss Bank Program. Indeed, many believe that the anonymity of virtual currency transactions provides a comparable opportunity to obtain tax-free gains for cryptocurrency investments. The fact that the identity of the coin owners are encrypted, combined with the uncertainty among taxpayers of their reporting obligations for cryptocurrency transactions, present a fertile area for potential noncompliance, as well as an enforcement challenge.
As an initial step to address this problem, in 2014, the IRS issued public Notice 2014-21 to provide guidance for the tax treatment of transactions involving virtual currency. The IRS confirmed that virtual currency that can be converted into traditional currency constitutes property for tax purposes. Thus, a gain or loss realized by the sale of cryptocurrency must be reported on a taxpayer’s returns.
Additionally, the receipt of units of cryptocurrency for services similarly must be reported as income at the time of its receipt at the fair market value of the unit. Nevertheless, out of approximately 120 million individual electronic tax returns filed annually between 2013 and 2015, less than 900 taxpayers in each of the relevant years reported a virtual currency transaction. During this time frame, Coinbase, one of the largest cryptocurrency exchange platforms, serviced approximately 5.9 million customers, and more than 14,000 Coinbase users either bought, sold, sent, or received at least $20,000 worth of cryptocurrency in a given year.2 The numbers clearly do not add up.
In 2016, the IRS took a significant step to address this issue, and, following its playbook from the Swiss Bank Program, issued a John Doe summons to Coinbase seeking expansive information regarding U.S. taxpayers’ use of this platform. The request included transaction logs, records of payments processed, and account statements. Following Coinbase’s legal challenges, the summons was narrowed to accounts with a transaction of at least $20,000 between 2013 and 2015. As of February 23, 2018, approximately 13,000 Coinbase customers were informed that their records would be turned over to
On July 2, 2018, the IRS stepped up its efforts and announced a focus on virtual currency as part of a new tax enforcement campaign. The IRS has reportedly assigned elite veteran criminal agents to investigate whether bitcoin and other cryptocurrencies are being used to evade taxes. Chief of IRS Criminal Investigation Don Fort stated that it is possible to use bitcoin and other cryptocurrencies in the same fashion as foreign bank accounts to facilitate tax evasion and that, while the agency has yet to charge anyone, the cases will come.
Based on this newest campaign, the IRS’s enforcement efforts are likely to focus on:
individuals who redeem, transfer, or exchange virtual currency;
companies that pay individuals for personal services in virtual currency; and
individuals who receive compensation in the form of virtual currency for providing personal services.
This sequence of investigative tools implemented by the DOJ and the IRS is strikingly similar to the measures utilized in the Swiss Bank Program.
Importance of Taking Action Now
There is no question that the IRS is prioritizing the enforcement of cryptocurrency reporting. Accordingly, taxpayers and cryptocurrency platforms should prepare for the application of the highly effective, but relatively inexpensive, tools utilized in the Swiss Bank Program to bring those involved in virtual currency transactions into reporting compliance.
Cryptocurrency platforms should be mindful of potential criminal liability for facilitating tax evasion. If the penalties imposed on the non-compliant Swiss banks are indicative of the future treatment of cryptocurrency, then facilitating platforms determined to be complicit in tax evasion can expect to turn over up to 50 percent of the maximum aggregate of all non-compliant accounts. Likewise, taxpayers who intentionally fail to report virtual currency transactions could face severe criminal penalties, such as fines up to $250,000 and imprisonment.3
There are measures that cryptocurrency exchange platforms can implement now to avoid or reduce their potential exposure, such as developing corporate compliance programs to ensure their platforms are not being used to facilitate tax evasion. These include policies and procedures, as well as internal controls, to prevent the individuals from intentionally circumventing U.S. laws.
Likewise, individuals who use virtual currency and have concerns that they are not correctly reporting these transactions should seek advice from an attorney or certified public accountant. If the unreported transactions are substantial, the IRS has a voluntary disclosure program that permits individuals and companies who have failed to report substantial amounts of taxes to amend prior tax returns and potentially receive penalty abatements (or at least mitigated penalties) in exchange for coming forward. Individuals considering entering the IRS voluntary disclosure program should seek legal counsel immediately. The program is not open to individuals or companies who are already selected for audit.
The tax man is coming again, and individuals and exchange platforms who do not take action now risk being swept up into the next enforcement wave and likely will face penalties similar to those imposed in the Swiss Bank Program. The risk of detection is high, because the DOJ and the IRS now have a blueprint for successful prosecutions that they are plainly implementing. – ©2018 BLANK ROME LLP
Internal Revenue Code § 7609(f). A John Doe summons or subpoena does not list the name of the taxpayer under investigation, as the taxpayer is unknown to the IRS.
United Sates v. Coinbase, Inc., No. 17-CV-01431-JSC, 2017 WL 5890052, at *4 (N.D. Cal. Nov. 28, 2017).
Willful tax evasion can result in imprisonment and fines up to $250,000. 26 U.S.C. §§ 7201, 7203, 7206. However, if signs of fraud are absent, the IRS may fine the taxpayer a penalty of 20 percent of the underpayment. 1 I.R.M. Abr. & Ann. § 220.127.116.11.