As part of the IRS enforcement campaign targeting virtual currency holders, the IRS has begun sending letters to certain taxpayers advising them to review their prior year returns. The IRS is mailing more than 10,000 “education letters” to taxpayers they believe may have incorrectly reported virtual currency transactions. These “soft” notices do not indicate that an audit of the underlying return has begun; therefore, it is still possible for taxpayers to amend prior errors and omissions.
The letters come in three variations: Letter 6173, Letter 6174 or Letter 6174-A; all three warn of future civil and criminal enforcement activity for individuals who under reported their income derived from digital asset activities and recommends individuals, who in fact did under report, amend their returns immediately to include the income. Letter 6173 is the most onerous, it requires the taxpayer to provide the IRS with a summary of relevant tax positions taken, along with supporting documents and affirm under penalty of perjury that all documents and prior year returns are correct.
While the receipt of these letters may be startling for individuals, the letters were most likely sent to all individuals known by the IRS to have had a digital asset trading account. The IRS has been collecting information on taxpayer virtual currency transactions for several years now. In addition to the 14,000 individuals identified in the 2017 Coinbase Summons, the IRS has also increased its usage of data analytics, principally through a large contract with the blockchain tracing firm, Chainalysis. While identified as likely holders of crypto currencies, taxpayers appear to be receiving these letters regardless of whether they properly, or improperly, reported their digital asset income.
The timing of these letters is also interesting. The IRS is currently working to finalize long awaited guidance addressing many uncertain issues surrounding the taxation of virtual currencies. The guidance is expected sometime this fall. However, these letters were sent in advance of this new guidance. The only other guidance addressing the taxation of virtual currencies is IRS Notice 2014-21, which simply states that virtual currency is property for federal tax purposes. The IRS letters relate to tax returns that would have been filed after the 2014 Notice, and no new guidance has been issued. Therefore, on the eve of the issuance of significant new guidance, taxpayers and their tax return preparers are being asked to affirm under penalty of perjury that prior year returns are accurate despite having no new guidance.
Taxpayers receiving any of these IRS letters should consult their tax advisers, and carefully review their prior year returns to ensure accuracy. An amended return should be filed as soon as possible if an error or omission is found. Regardless of whether a taxpayer properly reported their income, the receipt of this letter indicates the IRS is aware of their digital asset activity. Going forward, the proper reporting of virtual currency transactions should be an area of increased focus during tax return preparation and review because it will clearly be an area of IRS focus.