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Government’s Latest Move On Cryptocurrency Taxation

$1.1 Trillion Infrastructure Bill Is Government’s Latest Move On Cryptocurrency Taxation
The proposed infrastructure bill valued at just over $1 Trillion over a 5-year period has recently made its way through the senate1. The Bipartisan Infrastructure Deal is monumental and would make some of the largest federal investments in public transit, clean drinking water, bridges, and electrical vehicle infrastructure in the history of the United States. Unfortunately, these things are never as simple as they seem. Although the bill had bipartisan support with a voting of 67-32, it is still not fully out of the woods yet. The bill itself is over 2,000 pages in length and includes funding for some of the projects mentioned as well as; highways, airports, cyber defense, and climate change just to name a few. This deal comes as the democrats and the Biden administration ready a much larger $3.5 trillion package that is currently being considered under budget rules which would only need 51 senators with Vice President Kamala Harris able to break a potential tie.

 

Key to Infrastructure Deal and New Stimulus is the Taxation of Cryptocurrency
The Bipartisan Infrastructure Deal includes $550 Billion in new federal investment in America’s Infrastructure. There is a lot to unpack here, but what is of real interest is how government officials have proposed to fund the bill. According to a White House Briefing Room Fact Sheet2 the bill will be fully funded through a combination of unspent emergency relief funds, targeted corporate user fees, revenue generated from the bill itself, and the strengthening of tax enforcement on cryptocurrencies.

The cryptocurrency market is relatively young having only been around for a little over a decade. However, over the past couple of years, the crypto market has exploded and caught the attention of many including various governments. At the time of writing, the crypto market’s estimated value is of around $1.6 Trillion with hundreds of billions being traded every day. You could say it is getting to the point where it is hard to ignore. For the United States Federal Government not only has ignoring the cryptocurrency market proven to be increasing difficult it has also become increasingly costly. IRS Chief Charles Rettig says3 the US is losing about a trillion dollars every year in unpaid taxes. He credits this growing gap, at least in part, to the rise of the cryptocurrencies market.

 

Current Efforts and Future outlook of Cryptocurrency Taxation
As it stands the IRS treats virtual currencies as property and they are taxed in a very similar manner to stocks or real property through a long or short-term capital gains tax. 2019 was the first year the IRS asked taxpayers if they had dealt in crypto. They posed the question on a supplemental schedule form to be attached to a 1040. However not all taxpayers are required to fill out said schedule and in 2020 the IRS decided to add the same question onto the 1040 form itself. Since then, their efforts have only snowballed and in 2021 the IRS begun to subpoena some centralized crypto exchanges for information about non-compliant US taxpayers. The IRS is not alone as President Joe Biden also seems determined to tighten up restrictions on tax dodgers, including those parking their cash in crypto.

The president’s 2022 Budget Proposal4 in part consists of a new series of crypto reporting requirements and the US Treasury Department’s “Greenbook”5 also calls for more comprehensive reporting requirements for cryptocurrencies. This coupled with Biden’s proposed 39.6% top tax rate on capital gains and dividends for taxpayers in the higher tax brackets could really shake up the way crypto is taxed. The latest Bipartisan Infrastructure Deal has proposed to be financed, at least in part, by strengthening the taxation of cryptocurrencies. With potentially more stimulus and spending packages on the way the government is going to continue to look for way to increase its revenues, and by the looks of things they have already set their sights on the cryptocurrency market.

Of course, as is typical with all matters tax related, this is going to be a very long and complicated process. Especially when you consider how fast the crypto market is growing and continually evolving. Earlier this year the courts authorized the IRS to issue so called John Doe summons to Kraken and Circle, two crypto exchange operators. These John Doe summonses are essentially a way for the IRS to seek information about unnamed taxpayers from a third party. It allows them to obtain names, documents and other requested information concerning all taxpayers in a certain group. Although, this may not be the most efficient way of tracking down non-compliant crypto users, it is quite effective. The IRS has also partnered with TaxBit, a software capable of going through and examining crypto currency wallets, to determine what was bought and sold in crypto. Very soon the federal government and the IRS will have the capabilities to tax and track crypto transactions much like they do with cash.

 

Reality of the Current Taxpayer Situation
Unfortunately, as things are right now it can be quite easy to unintentionally fall into noncompliance when it comes to cryptocurrency trading. Typically, when you trade more traditional assets such as stocks and bonds through a brokerage you receive a 1099-B Form. This form outlines all your transaction proceeds and makes reporting relatively easy. Unfortunately, it is not as simple for crypto. In fact, many crypto exchanges do not report anything to the IRS. There is however a 1099-K6 form that some crypto exchanges have begun to provide. The 1099-K form is usually given to individuals who have engaged in at least 200 transactions worth $20,000 or more. However, a looming issue still exists with the 1099-K form. It only reports the total value of the transaction without accounting for the initial amount the individual paid for the cryptocurrency. Essentially, you have no cost basis that is reported on the form making it difficult for someone to calculate the correct amount of capital gain or loss. Not to mention any interest earned on bitcoin that may be in your crypto wallet is also considered income and must be taxed as such.

On the other hand, you have a group of people who are actively looking for ways to avoid tax on their cryptocurrency investments. Since cryptocurrencies are treated as property, unlike stocks, bonds and other commonly traded securities, Wash Sale Rules7 do not apply to them. A wash sale occurs when you sell or trade securities at a loss and within 30 days before or after the sale you do one of the following:

1: Buy Substantially Identical Securities
2: Acquire substantially identical securities in a fully taxable trade
3: Acquire a contract or option to buy substantially identical securities

Wash Sale Rules are meant to prohibit investors from deducting losses related to wash sales. This has led some cryptocurrency traders to harvest tax losses. You can harvest an unlimited amount of losses and carry them forward into an unlimited number of tax years. When an investor goes to cash out of their cryptocurrency, they can use these accumulated losses to offset the amount they own to the IRS through the capital gains tax assuming you can substantiate your calculations to the IRS.

This is only really scratching the surface. Nowadays people are purchasing cryptocurrency with other cryptocurrency and even gambling with it in exchange for more crypto. One thing is for certain and that is that the cryptocurrency market is here to stay. The government has a long and strenuous game of catch up to play if it hopes to capture this potential stream of juicy tax revenue. The value of the cryptocurrency market has appreciated around 75% over the past year alone. The race is truly on, and you best believe the IRS and the federal government are going to do everything they can to tax your cryptocurrency.

 

Tips for the Taxpayer
The best precaution you can take to ensure you are being fully compliant, and continue to be so, with your crypto currency investments is to record everything. The more sophisticated and accurate you get the better. A spreadsheet or something as simple as taking screen shots of price levels when you buy, and sell can save you from getting into trouble with tax authorities. It’s important to note that the crypto currency market is still very young and so is the regulation surrounding it. Everything is subject to change when it comes to crypto, so the more information you have to back your estimates the better.

What Is IRS Notice Of Deficiency?

 

Ordinarily, taxpayers file their income tax returns each year with the IRS and hear nothing more.  Rather, the Internal Revenue Service (“IRS”) simply processes the tax return, assesses the reported amount of tax due, and accepts and credits the taxpayer’s payment against the reported tax amount.  In this manner, life moves on until the same process is repeated again the next year.

 

But, there are times in which the IRS disagrees with the amount of tax reported on a taxpayer’s return.  In these instances, the IRS must utilize so-called “deficiency procedures” to communicate to the taxpayer the IRS’ belief that adjustments should be made to the return.  These deficiency procedures provide taxpayers with significant procedural rights to contest the IRS’ determinations.  This article discusses the deficiency procedures including the Notice of Deficiency (“NOD”) the IRS must issue prior to making an assessment of federal tax.  This article also discusses the taxpayer’s right to challenge the IRS’ determinations in the NOD through filing a petition with the United States Tax Court (“Tax Court”).

 

The Notice of Deficiency 
The NOD is the formal correspondence from the IRS to the taxpayer asserting that additional taxes are due.  It may be issued after a tax return has been filed or even where the taxpayer fails to file a return.
The Internal Revenue Code (the “Code”) provides information that should be in the NOD.  See I.R.C. § 7522.  However, the Tax Court has been more generous with the IRS, holding that a NOD may be valid even without all the required information.  See Jarvis v. Comm’r, 78 T.C. 646 (1982).  Indeed, the Tax Court only requires the NOD to “provide a formal notification that a deficiency in taxes has been determined.”  Pietz v. Comm’r, 59 T.C. 207, 213-14 (1972); see also Rochelle v. Comm’r, 116 T.C. 356 (2001) (IRS’ failure to include in NOD information required under the RRA of 1998 did not invalidate the NOD).
The IRS is not required to issue a NOD with respect to all federal taxes.  Rather, a NOD may be issued only for:  (1) income taxes; (2) estate, gift, and generation-skipping transfer taxes; (3) self-employment taxes; (4) certain withholding taxes (e.g., those regarding payments to non-resident aliens and foreign corporations); and (5) certain excise taxes (e.g., those imposed on public charities and private foundations).  The IRS may also issue a NOD to go after third parties, such as transferees and fiduciaries, regarding income, estate, and gift taxes.  See I.R.C. § 6901.
The IRS utilizes various form numbers to issue a NOD to a taxpayer.  Generally, the type of NOD will be governed by the circumstances.  For example, the IRS commonly utilizes CP3219A to propose adjustments to a taxpayer’s tax return where the IRS received information from a third party that does not match the taxpayer’s tax return.

 

The “Last-Known Address” Rule 
As discussed above, the IRS gets somewhat of a pass regarding the form and substance necessary to constitute a valid NOD. The same cannot be true with respect to the delivery requirements for a NOD.  More specifically, the Code requires that the IRS deliver the NOD to the taxpayer’s last known address either by certified or registered mail.  See I.R.C. § 6212.  The taxpayer’s last known address, for these purposes, is the last address reported by the taxpayer on his or her most recently filed return.  However, a taxpayer may formally change his or her last known address through the filing of a Form 8822, Change of Address.
Taxpayers who do not receive a NOD may challenge any subsequent assessment of federal tax.  In most cases, taxpayers will discover the IRS’ failure to comply with the last known address when the taxpayer receives IRS collection notices.  Here, taxpayers may file a petition with the Tax Court and move to dismiss the petition for failure of the IRS to properly deliver the NOD.  After the motion to dismiss has been filed, the IRS must produce a copy of the NOD and proof of proper mailing.  If it cannot, the Tax Court will dismiss the petition in the taxpayer’s favor.  See, e.g., Pietanza v. Comm’r, 92 T.C. 729 (1989), aff’d, 935 F.2d 1282 (3d Cir. 1991).

 

The “90-Day” Rule 
If the NOD is properly delivered, the taxpayer has 90 days to file a petition with the Tax Court unless the NOD was mailed to a taxpayer outside the United States.  Because the 90-day period is jurisdictional, the Tax Court is unable to grant additional time to file the petition.  See Estate of Cerrito v. Comm’r, 73 T.C. 896, 898 (1980).
The “timely-mailed, timely-filed” rule provides that a taxpayer’s petition is timely filed with the Tax Court if the taxpayer mails the petition via a proper mail service (including USPS) and the letter is postmarked within the 90-day period.  For certified mail deliveries, the postmark date is the date USPS stamped the green card.  See Treas. Reg. § 301.7502-1(c)(2).  More recently, taxpayers can avoid the mail and file their petitions electronically with the Tax Court.
If a taxpayer misses the 90-day filing period, the taxpayer is unable to challenge the pre-assessment procedures of the IRS. Accordingly, the IRS will assess the tax and mail the taxpayer a demand for full payment.  Because the taxpayer has lost his or her right to challenge the determination in the Tax Court, the taxpayer must full pay the taxes, penalties, and interest; file an administrative claim for refund with the IRS; and if the claim for refund is denied or unanswered, sue the United States in the federal district court or U.S. Court of Federal Claims.

 

The Tax Court Petition 
Conversely, taxpayers who timely petition the Tax Court may raise arguments as to why the proposed adjustments are in error.  Without doubt, the substance of the petition is extremely important.  And a failure to properly challenge the IRS’ determinations can be costly.
Thus, taxpayers should properly raise all issues in their petition.  If a taxpayer fails to raise an issue, the Tax Court may consider the argument waived.  See T.C. Rule 34(b)(4); Toyota Town, Inc. v. Comm’r, T.C. Memo. 2000-40.  Indeed, in one case, the Tax Court held that although a NOD proposed adjustments for several tax years, the taxpayer was limited to challenging the proposed adjustments in only one year because that was the year the taxpayer raised in his petition.  See O’Neil v. Comm’r, 66 T.C. 195 (1976).
Additional requirements for the petition may be found in Rules 31 through 34 of the Tax Court Rules of Practice and Procedure.

 

Parting Thoughts 
The NOD provides significant procedural rights to taxpayers.  After receipt of a NOD, taxpayers should calendar the 90-day deadline to ensure the filing of their petition is timely.  In addition, taxpayers should utilize the 90-day grace period to ensure that they have all the information necessary to file a proper petition with the Tax Court.  Taxpayers who miss the 90-day deadline or improperly fail to raise issues in their petitions run the risk of having to fight the IRS through collections, such as levies or lien filings.