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IRS Attacking Virtual Currency with audits

by | Dec 16, 2019 | Taxation

IRS Keeps Attacking Virtual Currencies

it appears that a sure way to be audited by the IRS is to have virtual currency transactions. I have been saying for many years, since I first learned about Bitcoin, that it is a commodity not a currency and therefore is subject to capital gain or loss. The IRS has issued a series of regulations with that interpretation. Virtual currencies are not currencies they are commodities. They are treated no differently than if you used any commodity to purchase or sell services or goods. The tax is calculated based upon the value of the virtual currency to the seller and the buyer who uses the virtual currency can have capital gain or loss depending upon whether the virtual currency increase in value while the buyer held the currency. Using virtual currency is a “red flag” to the IRS and is now not only one of the questions on audit but is actually listed on the tax return.

If you use virtual currency, you definitely need to have your tax return professionally prepared. Also, there may be any to discuss this with a tax lawyer in anticipation of potential federal and state audits.

Virtual currency exchange summons not quashed but IRS ordered to amend it

Zietzke, (DC WA 11/25/2019) 124 AFTR 2d ¶2019-5484

A federal district court has denied a taxpayer’s attempt to quash an IRS summons to a virtual currency exchange. However, the court ordered IRS to amend the summons so that it did not demand information irrelevant to the IRS’s audit of the taxpayer’s return.

Background—summons enforcement. Code Sec. 7602(a) gives IRS the power to issue administrative summonses. IRS’s power to issue summonses has been construed broadly in IRS’s favor. (Euge, (S Ct 1980) 45 AFTR 2d 80-757)

To enforce an administrative summons, IRS must first present a prima facie case for enforcement. IRS establishes a prima facie case by showing that

  1. IRS issued the summons for a legitimate purpose;
  2. The summoned data may be relevant to that purpose;
  3. IRS does not already possess the summoned data; and
  4. IRS followed the administrative steps required by the Code for issuance and service of a summons ( Powell factors). (Powell, (S Ct 1964) 14 AFTR 2d 5942)

IRS usually presents a prima facie case for enforcement by introducing a sworn declaration of the revenue agent who issued the summons that states all of the Powell factors have been met. If IRS establishes a prima facie case, then the burden shifts to the petitioning taxpayer to show that the IRS is attempting to abuse the court’s process or is lacking in good faith. (Dynavac, Inc., (CA 9 1993) 72 AFTR 2d 93-6305) The burden on the taxpayer to disprove the IRS’s assertions is “heavy.” (Dynavac, Inc., (CA 9 1993) 72 AFTR 2d 93-6305)

Background—virtual currency. Notice 2014-21, 2014-16 IRB 938, provides that virtual currency is treated as property and that general tax principles applicable to property transactions apply to virtual currency transactions. Thus, taxpayers are taxed on the gain or loss realized when they sell or exchange virtual currency. A taxpayer’s gain or loss is determined by looking at the difference between the virtual currency’s basis and the amount the taxpayer receives in exchange for the virtual currency. A taxpayer’s basis in virtual currency is the fair market value of the virtual currency in U.S. dollars as of the date of receipt. Virtual currency’s fair market value is usually determined by the price at which the taxpayer purchases the virtual currency. (Notice 2014-21)

Facts. The taxpayer, William Zietzke, self-prepared his 2016 federal income tax return. On that return, he reported long-term capital gains from two virtual currency transactions. However, in 2017 Mr. Zietzke discovered he made a mistake when he reported the two virtual currency transactions on his 2016 return, and he filed an amended return for 2016 that omitted those transactions and claimed a refund.

IRS decided to audit Zietzke’s 2016 amended return and sent a summons to virtual currency exchange Bitstamp after IRS learned that Zietzke had conducted at least one virtual currency transaction in 2016 using Bitstamp. IRS’s summons directed Bitstamp to produce for examination books, records, papers, and other data relating to Zietzke’s holdings with Bitstamp. Zietzke then sought to quash the summons.

Taxpayer’s argument. Zietzke asked the court to quash IRS’s Bitstamp summons claiming IRS

  1. Issued the summons in bad faith;
  2. Sought information irrelevant to its audit of his 2016 amended return because it requested “all account history information for transactions or events relating to any covered accounts;”
  3. Already possessed the information that it sought from Bitstamp; and
  4. Failed to follow the administrative steps required by the Code for issuing and serving a summons.

Summons not quashed but IRS ordered to amend it. The federal district court denied Zietzke’s request to quash IRS’s Bitstamp summons, but concluded the summons was overbroad because it sought information irrelevant to its audit of the taxpayer’s 2016 amended return. Therefore, the court ordered IRS to amend the summons.

The court rejected Zietzke’s argument that IRS was acting in bad faith because it refused to accept Zietzke’s word that Bitstamp had no information relevant to IRS’s audit of his 2016 amended return. According to the court, “the IRS is not required to rely on [a taxpayer’s] claim that he has provided the agency with everything it needs to know.”

Similarly, the court rejected Zietzke’s argument that the summons demanded documents and information already in IRS’s possession. IRS was not required to accept Zietzke’s word that he had already given IRS all relevant documents and information demanded in IRS’s Bitstamp summons. IRS was entitled to confirm Zietzke’s assurances that he provided IRS with all relevant documents and information by summoning Bitstamp’s records.

The court also found that Zietzke did not present any specific facts showing that IRS failed to comply with any administrative requirements for issuing and serving the summons. Therefore, Zietzke failed to rebut IRS’s prima facie case.

However, the court agreed with Zietzke that IRS’s summons to Bitstamp requested information irrelevant to its audit of Zietzke’s 2016 amended return. While IRS needed pre-2016 information regarding the price Zietzke paid for the virtual currency he sold in 2016 in order to properly calculate any resulting 2016 gain or loss, the summons asked for “all account history information for transactions or events relating to any covered accounts.” This request would require Bitstamp to produce information relating to Zietzke’s virtual currency sales pre-2016, even though such sales could not impact Zietzke’s gain or loss on virtual currency sold in 2016. Therefore, the court determined, the summons had to be amended to exclude the request for irrelevant information before it could be enforced.

Note: This article was reported in the daily email tax news by Thompson Reuters.