Have You Disclosed Offshore Cryptocurrency and NFT Activities to the IRS?

Allen Barron, Inc.

Have you fully disclosed offshore cryptocurrency and NFT activities to the IRS? Earlier this month, the US Department of Justice announced the indictment of a Texas man for tax returns that were inaccurate, incomplete, or untrue as well as setting up cash deposit transactions in an attempt to avoid detection. None of these schemes worked. Why? How long has the IRS prepared to pursue US taxpayers for unreported cryptocurrency and NFT transactions? How will the IRS learn of a taxpayer’s offshore accounts and crypto assets?

The IRS first addressed the issue of cryptocurrency on March 25, 2014, in a virtually ignored (no pun intended) “Notice” #2014-21 whose purpose was to describe how US taxation laws applied to virtual currency (cryptocurrency). In Notice #2014-21, the IRS established that virtual currency was to be treated as property and not currency for US taxation and tax filing purposes. The Notice required US taxpayers to calculate gross income based on the fair market value of their virtual currency assets (in US dollars) at the time of acquisition or receipt. This “basis” would then assist the taxpayer with the calculation of a “gain” or “loss” upon the sale of the asset. The Notice also reinforced the requirement for US taxpayers to report any virtual currency gains or losses on their US federal tax return. This was the first warning that US taxpayers should have disclosed cryptocurrency and NFT activities to the IRS.

This initial Notice was bolstered by the issuance of the IRS Revenue Ruling 2019-24. This ruling provided guidance on transactions referred to as a “hard fork” or an “airdrop.” A hard fork was a type of cryptocurrency transaction that split a blockchain (for whatever purpose), often resulting in the issuance of a new brand of cryptocurrency. An “airdrop” is usually a promotional activity that places virtual currency (cryptocurrency) in the wallet (storage account) of multiple US taxpayers, often at no cost. Generally speaking, the IRS Revenue Ruling defined when a taxable event occurred after a hard fork or airdrop.

The IRS ramped up the pressure when it asked US taxpayers to answer a question at the top of the 2021 Form 1040: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose any financial interest in any virtual currency (yes or no)? The 2022 Form 1040 was a bit more extensive in its language regarding the acquisition, sale, exchange, gifting or disposal of any digital asset (or a financial interest in a digital asset). You will find this same question at the top of the 2023 Form 1040.

It is important to note US taxpayers sign their tax return declaring they have examined (the entire return) and to the “best of my knowledge and belief” the information it contains is “true, correct and complete” under penalty of perjury.

The arrest earlier this month alleges a US taxpayer from Texas sold $3.7 million of bitcoin in 2017 to purchase their residence. The taxpayer is accused of filing a false 2017 tax return inflating the basis in the sale of the cryptocurrency and underreporting the “resulting” gain. In 2018 and 2019 the taxpayer is accused of selling bitcoin valued in excess of $650,000 and the IRS alleges the taxpayer failed to report these sales on their federal tax returns.

In addition, the indictment alleges the taxpayer made a series of bank deposits of less than $10,000 in an attempt to avoid federal transaction reporting requirements. The penalties associated with these charges include three years in prison for each count of filing a false tax return and up to five years for each count of structuring false bank deposits to avoid federal reporting.

The writing is on the wall for US taxpayers who have not disclosed offshore cryptocurrency and NFT activities to the IRS. The agency currently receives electronic reporting from cryptocurrency exchanges here in the US and worldwide and has deployed Artificial Intelligence and advanced computing technologies to scour this information and compare it to the tax reports of individual US taxpayers.

It may also surprise some who hold cryptocurrency or NFTs to learn that a simple transfer of digital currency or assets from one “wallet” to another is a taxable transaction under US tax law. The arrest of a Texas man may be one of the first (if not actually the first) criminal charges associated with tax evasion based on digital currency activities.

Are you concerned because you haven’t disclosed offshore cryptocurrency and NFT activities to the IRS? It is in your interest to contact an experienced tax attorney to discuss your unique circumstances and the best strategies to come into compliance with IRS digital currency reporting requirements. Ask about the protections of the attorney-client privilege and the options available to reduce your exposure to substantial financial and criminal penalties.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Allen Barron, Inc.

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