It’s been the “Wild West” for the users of virtual currencies like bitcoin for years, and the times they are … well, not changing very much at all.
This is especially true when it comes to compliance with the federal tax code. Regulators and federal authorities have been slow to keep up with bitcoin, and the Internal Revenue Service is no exception.
According to the Treasury Inspector General for Tax Administration (TIGTA), virtual currency use continues to climb and the IRS is not doing nearly enough to police these transactions.
A recent review by the watchdog found several deficiencies in the way the IRS currently addresses virtual currencies, specifically bitcoin, which TIGTA identifies as comprising “nearly 82 percent of the entire virtual currency market.”
The report notes that the agency’s failure to provide proper guidance and investigate noncompliance has led to an increase in the “tax gap” — the estimated difference between “the amount of tax that taxpayers should pay and the amount that is paid voluntarily and on time.”
According to the IRS, the tax gap for tax years 2008 through 2010 was approximately $458 billion per year.
While the IRS issued a notice in March 2014 and launched the Virtual Currency Guidance Team, TIGTA says the agency has made little to no effort to follow up:
“… [T]here has been little evidence of coordinate between the responsible functions to identify and address, on a program level, potential taxpayer noncompliance issues for transactions involving virtual currencies.”
At present, the inspector general says the IRS still lacks an “overall strategy” to deal with bitcoin. What’s more, TIGTA points out that the Government Accountability Office raised these concerns three years ago, and yet the IRS’s position on virtual currency “has remained relatively unchanged.”
Indeed, the IRS has remained strangely quiet on the issue over the years, leaving only the March 2014 announcement (Notice 2014-21, “Virtual Currency Guidance”) as their official word on the matter.
That notice, however, did little to help those bitcoin users who want to “come out of the shadows” and comply with federal tax laws, as Bob Derber — an attorney with the Summit Legal Group and contributor to Coin Center — explained to the Tax Revolution Institute’s Fergus Hodgson in early August.
The crux of the issue lies with the IRS’s refusal to classify bitcoin and the like as actual currency, just like the legal tender that is issued from a central bank. Instead, the agency has insisted on treating bitcoin as “property,” which makes reporting requirements complicated, to say the least.
“Perhaps the most troubling aspect of this classification is that users are required to calculate the realized gains and losses of every transaction. In other words, if I buy one bitcoin at $500, and then spend it after it has risen in value to $750, I should report income of $250, and that goes for transactions as small as the purchase of a cup of coffee.”
Derber agreed and said at the time of the interview that “widespread non-reporting” is to be expected in the face of such an “unreasonable burden.”
To date, the IRS has not provided further comment on bitcoin or the various questions that Notice 2014-21 has since raised. The agency’s silence comes despite a letter from the American Institute of Certified Public Accountants in June calling for clarification, and — perhaps even more surprisingly — the IRS’s very own call for public comments on their notice.
This lapse was not lost on TIGTA who chastises the IRS in its report for taking “no action” to address the comments the agency received from the public on their Virtual Currency Guidance notice.
Down a Slippery Silk Road
While the IRS’s efforts to address bitcoin in terms of tax compliance has been minimal, TIGTA says the agency has done even less with regard to the “potential criminal activities” associated with the virtual currency.
Specifically, TIGTA wants the IRS to up its enforcement of bitcoin when it comes to violations of the Bank Secrecy Act. The inspector general points to the notorious “Silk Road” case as the prototypical example of a “successful collaborative Federal investigation.”
The Silk Road was a black market website that operated on the “dark web” from January 2011 to October 2013 when it was shut down by federal law-enforcement authorities.
TIGTA’s report describes the website as a “sophisticated and extensive criminal marketplace … where unlawful goods and services, including illegal drugs of virtually all varieties, were bought and sold regularly by the site’s users.”
In February 2015, Ross Ulbricht was convicted of being the “Dread Pirate Roberts” mastermind behind the Silk Road following an investigation by the FBI, DEA, and the IRS Criminal Investigation division. While Ulbricht maintains his innocence and his attorneys continue to seek an appeal, he is currently facing a life sentence without the possibility of parole.
TIGTA’s report notes that the Silk Road was designed to “include a bitcoin-based payment system that concealed the identities and locations of the users transmitting and receiving funds through the site.”
The watchdog warns that it is the “anonymity feature” of bitcoin and other virtual currencies that should be of particular concern, claiming that this is “what attracts unscrupulous individuals to their use.”
Ironically, it is this same anonymity that allowed federal agents to infiltrate the Silk Road marketplace in the course of their investigation. It is also what allowed two unscrupulous federal agents in particular to seize user accounts and steal hundreds of thousands of dollars worth of bitcoins from the site.
Both agents have since been convicted for their corruption and sentenced to several years in prison. DEA agent Carl Mark Force pled guilty to extortion, money laundering, and obstruction of justice, while Secret Service agent Shaun Bridges pled guilty to the theft of some $820,000 from Silk Road user accounts.
Their actions, however, have raised fresh questions about the integrity of the government’s investigation of the Silk Road and its case against Ulbricht. In fact, it is this corruption that is the basis for Ulbricht’s current appeal.
“They hijacked accounts. They changed passwords. They stole money. They were inside the guts of this website,” defense attorney Joshua Dratel argued before the Second Circuit Court of Appeals in New York City in early October.
“For us, this is a critical issue and what we wanted was a chance to put it before a jury,” he said.
Nevertheless, TIGTA wants to see the IRS pursue more Silk-Road type investigations, and is urging the agency to have all bitcoin users — both honest and dishonest alike — brought to heel.