- IRS Letter 6173: Notice that requests a response from the taxpayer about alleged noncompliance.
- IRS Letter 6174: Notice that requests taxpayer review their return and, if necessary, file an amended return
- IRS Letter 6174-A: Notice that there is a potential misreporting of virtual currency transactions and IRS may follow-up with enforcement actions
These cryptocurrency audits are targeted at individuals who have owned bitcoin (BTC), ethereum (ETH), litecoin (LTC), ripple (XRP), Zcash (ZEC), darkcoin/dash (Dash), and more.
If You Believe You’re A Target Of A Cryptocurrency Tax Investigation From The IRS, Then You Should Immediately Contact A The Tax Attorneys at Marini & Associates, PA
Before Disclosing Anything To The Government!
The IRS is getting a lot of its information about cryptocurrency users from virtual wallet provider Coinbase Inc. A California federal judge told Coinbase in November 2017 that it must hand over information on accounts with transactions greater than $20,000 and must provide the taxpayer ID, name, date of birth and address for the accounts.
Letter 6174 and Letter 6174-A each notify a taxpayer that the IRS has information regarding the taxpayer's account or accounts that contain virtual currency, explains activities that can trigger tax reporting obligations and does not require a response.
“Although both letters explicitly state, ‘You do not need to respond to this letter,’ Letter 6174-A warns recipients that additional correspondence about potential enforcement activity may follow,” according to Ziering. “Among other things, these letters are meant to put taxpayers on notice of the applicable rules, which would make further noncompliance a more serious issue.”
But Sarah E. Paul, a partner at Eversheds Sutherland, said that even though no response is required for Letters 6174 or 6174-A, the recipient should read the letter and reporting requirements, review his or her tax return for errors and if any are found correct them with the IRS through an amended return or delinquent return.
“You can't get the letter, ignore it and throw it in the trash,” she said. “You have to read it and review your return, at a minimum.”
Ziering said it is important to be aware that unlike the IRS offshore voluntary disclosure program, which provided leniency and had well-defined penalties for voluntarily declaring unreported offshore income, it is unclear what the penalties will be for disclosing unreported cryptocurrency transactions.
Think About Attorney-Client Privilege.
Letter 6173 is different from the other two letters because not only does it require a response, but in it the IRS says for one or more years between 2013 and 2017 the government has not received a federal income tax return or schedule reporting the recipient's virtual currency transactions. The letter instructs the recipient to either send in a statement of facts, signed under penalty of perjury, explaining what happened, file a delinquent tax return or file an amended return.
“If you get a Letter 6173, the best practice would be to consult with an accountant if you didn't have one before and also with an attorney to decide how you're going to respond to the letter, because there are three different options and a decision has to be made with which one you have to take,” Paul said.
“If you take option three, which is write a statement of facts explaining your position and make that statement of facts under penalty of perjury, you're really going to want to consult with an attorney before doing that.”
A letter recipient should not only consider seeking the help of an attorney but also think about talking to an accountant about filing or correcting tax returns, Paul said. However, if conversations occur between an attorney, accountant and client, it is crucial to think about how to protect the communications through attorney-client privilege, she said.
Attorney-client privilege, which protects the confidentiality of communications between lawyers and clients, generally does not extend to third parties. However, in 1961 the Second Circuit extended the attorney-client privilege to a third party in a case called U.S. v. Kovel , in which the court found that third-party communications are confidential if done to obtain legal advice.
In order for communications with a third-party accountant to fall under that protection, the accountant has to be engaged by the attorney to assist the attorney and not the client, Paul said. Establishing such a relationship would require an engagement letter between an attorney and the accountant, she said.
But legal advice must also be sought in order to extend the privilege, she said. So if, for example, the client decides to amend a tax return and the accountant is paid to simply amend the return, that would be pure accountancy that cannot be cloaked with privilege, she said.
“The idea is to exchange the privilege of the discussions between all three, client, attorney and accountant, so the conversations will be protected by the privilege even though you have a third party who's not a lawyer,” Paul said.
Consider Initiating a Voluntary Disclosure
A voluntary disclosure, which is a petition to the IRS that discloses tax noncompliance in exchange for avoiding criminal charges, may be appropriate in addition to responding to a letter or filing amended or delinquent returns.
In November the IRS made an update to Internal Revenue Manual procedures for delinquent taxpayers to disclose domestic or international noncompliance. Typically those who decide to initiate a voluntary disclosure are willful violators and want to avoid criminal charges.
To initiate a voluntary disclosure, a client must first request preclearance from the IRS Criminal Investigation division and promptly submit all documents using a Form 14457. The form requests information about the noncompliance in a narrative that lays out the facts, circumstances, entities, related parties and any professional advisers involved.
David W. Klasing, who founded the Tax Law Offices of David W. Klasing, and said he counted Satoshi Nakamoto, the pseudonym for the people or person who created Bitcoin, as one of his clients, said a voluntary disclosure might be more appropriate for clients who had more than $30,000 of owed taxes, because that larger amount could trigger jail time due to criminal sentencing guidelines.
The Coinbase summonses gave the IRS information on wallet accounts with transactions greater than $20,000, but Klasing said he was more concerned when the amount of taxes due exceeded $30,000, and at that amount he would advise a client to consider initiating a voluntary disclosure.
“I don't think the government will criminally prosecute someone unless they can put them in jail for at least a year,” he told Law360.
“The larger the number, the more concerned I am, because the amended return in and of itself can be viewed as criminal admission,” which is why initiating a voluntary disclosure may be appropriate, he said.
Examine Foreign Wallet Cryptocurrencies
Even those who did not receive letters should be put on notice to properly report cryptocurrency transactions and make sure cryptocurrencies held in foreign wallets are properly disclosed through any relevant informational returns, such as Reports of Foreign Bank and Financial Accounts.
“To the extent there are U.S. taxpayers holding virtual currency on foreign exchanges, there can also be foreign reporting requirements,” according to Rebecca M. Stork, an associate at Eversheds Sutherland. "Taxpayers may have to file an FBAR in such cases.”
In July 2018 the agency's Large Business and International Division launched a cryptocurrency campaign to address noncompliance through outreach and examinations, which could mean the government might be looking for additional tax noncompliance for cryptocurrency held in foreign wallets.
More recently the U.S., along with Canada, the U.K., the Netherlands and Australia, said they were working together to combat “enablers” of international tax evasion and crime that involves cryptocurrencies and were continuing to share information with one another. The countries created an alliance, the Joint Chiefs of Global Tax Enforcement, or J5, last year.
“I do think that information is going to be shared of this type and probably is already being shared by the members of the J5, which makes considering compliance — whether you have an FBAR requirement — even more important,” according to Paul.
Just because one receives a letter from the IRS to act on potential domestic cryptocurrency tax issues does not mean that person is off the hook for cryptocurrency held in wallets abroad, but it is difficult to advise without knowing the facts, Stork said.
“I think ultimately the takeaway I'd tell a taxpayer, if they wanted a 5 cent answer, is did you hold any currency at any time, at any point, on an exchange that was not based in the U.S.?” she said. “If so, you probably should consult with an attorney or an accountant who is intimately familiar with FBAR requirements.”
