If your business is involved with cryptocurrency in the U.S. in any way, the Internal Revenue Service may be watching you.
This new emphasis could mean headaches for the hedge funds and other businesses investing in cryptocurrencies but, as usual when it comes to audits, it’s likely to be a boon for tax attorneys.
Most crypto investors think their trading is completely anonymous. Now the IRS is going after them if they don’t report profits.
Last year, Wall Street law firm Seward & Kissel created a practice focused solely on cryptocurrency to address clients’ growing needs, Brett Cotler, an associate in the firm’s Taxation Group, tells ThirtyK.
“Cryptocurrency as a practice group is a natural extension of what our firm always does,” he says. “We have a couple dozen hedge funds clients predominantly or exclusively trading in crypto as well as many more interested in it.”
More funds may come knocking. Research firm Autonomous Next estimates there are 370 crypto funds with $8 billion to $10 billion in assets under management. And there are plenty of other Wall Street firms that plan to get in on the cryptocurrency action. A Thomson Reuters survey in April found one in five financial firms were looking at cryptocurrency trading, with the majority eyeing an entrance in the next three to six months.
Upping the Ante
“They are doing more criminal investigations of people for cryptocurrency trades that went unreported,” , a California tax attorney, tells ThirtyK. “Most crypto investors across the planet believed, in the beginning, there was no paper trail, that it was completely anonymous. In response to that, [the IRS] upped the ante.”
The IRS did not say exactly where it is targeting the audits, but the Large Business & International division serves corporations and partnerships with assets greater than $10 million, suggesting it’s setting its sights on institutional players.
Seward & Kissel’s Cotler says the IRS is unlikely to be going after “Joe Trader” with the initiative. “They might be looking at [initial coin offerings] and hedge funds.”
In its announcement, the IRS said it is not considering a voluntary disclosure program to specifically address tax non-compliance involving virtual currency. In other words, it won’t offer protection from civil and criminal liability to filers who voluntarily come forward and disclose non-compliance. Instead, it urges taxpayers with unreported virtual currency transactions to amend their returns “as soon as practical.”
Cryptocurrency as Property
Back in 2014, the IRS for transactions in virtual currency that treat it as property. That means general tax principles that apply to property transactions apply to crypto, so selling it, exchanging it and spending it are subject to capital gains taxes. The IRS continues to rely on that guidance: Last month’s announcement about the auditing campaign specifically mentions the 2014 .
But the cryptocurrency world has become more complicated than just buying and selling bitcoin (). There are ICOs, utility tokens, , security tokens and . Tax lawyers are busy figuring out what the guidance means for ICOs and hedge funds.
Take startups looking to raise money via an ICO. Cotler says there are questions about whether selling tokens is a non-recognition transaction akin to the sale of debt or equity, or whether it results in taxable income similar to selling inventory.
Meanwhile, tax attorneys are looking to see whether hedge funds and other institutional investors can apply the same tax techniques that investors and traders in stocks and commodities use. For instance, cryptocurrency investors would like to have the ability to deduct trading expenses from income. They’d also like the option to classify their capital gains and losses as ordinary gains and losses, which would allow them to use capital losses to offset regular income at tax time.