Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance

Virtual currencies, such as bitcoin, have grown in popularity in recent years. Individuals and businesses use virtual currencies as investments and to pay for goods and services. GAO was asked to review IRS's efforts to ensure compliance with tax obligations for virtual currencies.

This report examines (1) what is known about virtual currency tax compliance; (2) what IRS has done to address virtual currency tax compliance risks; (3) the extent to which IRS's virtual currency guidance meets taxpayer needs; and (4) whether additional information reporting on virtual currency income could assist IRS in ensuring compliance.

GAO reviewed IRS forms and guidance and interviewed officials at IRS, FinCEN, and other federal agencies, as well as tax and virtual currency stakeholders.

Taxpayers are required to report and pay taxes on income from virtual currency use, but the Internal Revenue Service (IRS) has limited data on tax compliance for virtual currencies. Tax forms, including the information returns filed by third parties such as financial institutions, generally do not require filers to indicate whether the income or transactions they report involved virtual currency.

IRS also has taken some steps to address virtual currency compliance risks, including launching a virtual currency compliance campaign in 2018 and working with other agencies on criminal investigations. In July 2019, IRS began sending out more than 10,000 letters to taxpayers with virtual currency activity informing them about their potential tax obligations.

IRS's virtual currency guidance, issued in 2014 and 2019, addresses some questions taxpayers and practitioners have raised. For example, it states that virtual currency is treated as property for tax purposes and that using virtual currency can produce taxable capital gains. However, part of the 2019 guidance is not authoritative because it was not published in the Internal Revenue Bulletin (IRB). IRS has stated that only guidance published in the IRB is IRS's authoritative interpretation of the law. IRS did not make clear to taxpayers that this part of the guidance is not authoritative and is subject to change.

Information reporting by third parties, such as financial institutions, on virtual currency is limited, making it difficult for taxpayers to comply and for IRS to address tax compliance risks. Many virtual currency transactions likely go unreported to IRS on information returns, due in part to unclear requirements and reporting thresholds that limit the number of virtual currency users subject to third-party reporting. Taking steps to increase reporting could help IRS provide taxpayers useful information for completing tax returns and give IRS an additional tool to address noncompliance.

Further, IRS and the Financial Crimes Enforcement Network (FinCEN) have not clearly and publicly explained when, if at all, requirements for reporting financial assets held in foreign countries apply to virtual currencies. Clarifying and providing publicly available information about those requirements could improve the data available for tax enforcement and make it less likely that taxpayers will file reports that are not legally required.

GAO is recommending that IRS clarify that part of the 2019 guidance is not authoritative and take steps to increase information reporting, and that FinCEN and IRS address how foreign asset reporting laws apply to virtual currency. IRS agreed with the recommendation on information reporting and disagreed with the other two, stating that a disclaimer statement is unnecessary and that it is premature to address virtual currency foreign reporting. GAO believes a disclaimer would increase transparency and that IRS can clarify foreign reporting without waiting for future developments in the industry. FinCEN agreed with GAO's recommendation.

Virtual currencies—digital representations of value that generally are not  government issued—have grown in popularity since their introduction  more than a decade ago. According to the Internal Revenue Service  (IRS), there are currently more than 5,000 known virtual currencies.  Individuals and businesses use virtual currencies as investments and to  make or accept payments for goods and services, among other uses.  These virtual currencies account for the equivalent of hundreds of millions  of dollars or more in daily transactions. The growth of virtual currencies  has raised questions about whether taxpayers who use them are fully  meeting their tax obligations.

According to IRS guidance, virtual currencies are treated as property for  tax purposes and income from virtual currency use is reportable on tax  returns. If taxpayers who use virtual currencies do not comply with their  tax obligations, they contribute to the tax gap, the difference between  taxes that are owed and actually paid. In September 2019, IRS estimated  an average annual gross tax gap of $441 billion for tax years 2011 to  2013.

You asked us to review IRS’s efforts related to virtual currency tax  compliance, guidance, and information reporting, which involves third  parties, such as financial institutions, reporting information on taxpayer  income or transactions to IRS and taxpayers. This report (1) describes  what is known about virtual currency tax compliance; (2) describes the  steps IRS has taken to address virtual currency tax compliance risks; (3)  evaluates the extent to which IRS’s virtual currency guidance meets  taxpayer needs; and (4) evaluates whether additional information  reporting could assist IRS in ensuring compliance.

To describe what is known about virtual currency tax compliance and the  steps IRS has taken to address virtual currency tax compliance risks, we  reviewed IRS documentation on the agency’s virtual currency tax  enforcement efforts, including information about the Large Business and  International Division’s virtual currency compliance campaign, which was  launched in 2018 to address noncompliance related to the use of virtual  currency through outreach and examinations. We interviewed IRS  officials about any data the agency had on virtual currency tax  compliance. For virtual currency tax compliance issues, we also  interviewed a nongeneralizable selection of tax practitioners, tax  attorneys, virtual currency industry advocates, and virtual currency  exchange executives. We selected these stakeholders to interview using  a snowball sampling approach, and, in total, we interviewed five individual  stakeholders and representatives of 10 entities. We also interviewed  officials from the Financial Crimes Enforcement Network (FinCEN),  Commodity Futures Trading Commission (CFTC), and Securities and  Exchange Commission (SEC) about coordination efforts that have been  made across agencies regulating virtual currencies.

To evaluate the extent to which IRS’s virtual currency guidance meets  taxpayer needs, we reviewed IRS’s guidance specific to virtual currency,  including Notice 2014-21, issued in March 2014, as well as Revenue  Ruling 2019-24 and Frequently Asked Questions (FAQs) released in  October 2019. We also reviewed and analyzed all of the public comments  IRS had received on Notice 2014-21 as of August 19, 2019. To assess  the reliability of these data, we requested information from IRS to identify  the quality controls in place to help ensure all comments were processed.  We determined that the data were sufficiently reliable for our purposes.

Prior to IRS issuing the Revenue Ruling and FAQs in October 2019, we  interviewed the stakeholders mentioned above to determine any taxpayer  concerns, any compliance challenges with virtual currency tax obligations,  and the extent to which IRS’s guidance was meeting taxpayer needs.  After the new guidance was issued, we contacted these same  stakeholders to gather their perspectives on the new guidance, and  received responses from four of the five individuals and six of the 10  organizations we had contacted.

To evaluate whether additional information reporting could assist IRS in  ensuring compliance, we reviewed IRS’s requirements for information  reporting for virtual currency transactions. We interviewed IRS officials  about how IRS’s third-party and taxpayer information reporting processes  and forms assist in detecting noncompliance for virtual currencies. We  reviewed the websites of a judgmental selection of nine major virtual  currency exchanges based in the United States to identify any policies  about tax information reporting. We also interviewed the stakeholders  mentioned above to obtain their views on what virtual currency  information is being reported to IRS; whether additional information  reporting would help to ensure tax compliance; and, in interviews with  executives from two virtual currency exchanges, what burden, if any,  information reporting does or could impose on virtual currency exchanges  and virtual currency users.

We conducted this performance audit from October 2018 to February  2020 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

Background Types and Uses of Virtual Currency

While there is no statutory definition for virtual currency, IRS guidance  has described virtual currency as a digital representation of value that  functions as a medium of exchange, a unit of account, or a store of  value. Some virtual currencies can be used to buy real goods and  services and can be exchanged for U.S. dollars or other currencies.

A cryptocurrency is a type of virtual currency that employs encryption  technology and operates on distributed ledger technology, such as  blockchain. Distributed ledger technology allows for users across a  computer network to verify the validity of transactions potentially without a  central authority. For example, a blockchain is made up of digital  information (blocks) recorded in a public or private database in the format  of a distributed ledger (chain). The ledger permanently records, in a chain  of cryptographically secured blocks, the history of transactions that take  place among the participants in the network. For the purposes of this report, we use the term virtual currency as a broad term that includes  both cryptocurrencies, which use distributed ledger technology, and  digital units of exchange that do not use that technology but still meet  IRS’s definition of a convertible virtual currency, as defined in Notice  2014-21. Figure 1 shows a simplified representation of how distributed  ledger technology is used to circulate virtual currencies.

Bitcoin, which emerged in 2009, is the first and most widely circulated  blockchain-based cryptocurrency. Bitcoins are created through a process  called mining. Bitcoin miners download software to solve complex  equations to verify the validity of transactions taking place on the network,  and the first miner to solve a problem is awarded coins in return. Once a  problem is solved, the transactions are added as a new block to the  distributed ledger.

Users transact in virtual currencies electronically through a network, and  may use virtual wallets to manage their virtual currency. Some virtual  currencies can be used as investments and to purchase goods and  services in the real economy. For example, some retailers accept virtual  currency as a form of payment. Virtual currency exchanges provide a  platform where users can transact in different types of virtual currencies  or exchange them for government-issued currencies or other virtual  currencies.

Estimates of the Size of the Virtual Currency Market

The fair market value of some virtual currencies has changed dramatically  over time. For example, according to one index, the average value of one  bitcoin was just under $20,000 in mid-December 2017. By early  February 2018, one bitcoin was valued at about $7,000, before falling  below $4,000 in December 2018, and again rising to over $9,000 in  November 2019.

The size of the virtual currency market is unknown due to limitations in  available data. For example, one recent analysis concluded that a widely  cited source for data about bitcoin trading included exaggerated data that  gave an inflated impression of the size of the actual market.

Nonetheless, there are data that may provide some context for the size of  this market:

As of April 2019, 10 major virtual currency exchanges collectively  handled an average daily trading volume in bitcoin of more than $500  million, according to Bitwise. For comparison, the Federal Reserve  Banks’ Automated Clearing House (a traditional payment processor)  processed $103 billion in payment transactions on average per day in  2018.

According to one index, the total market capitalization of bitcoin, the  most widely circulated virtual currency, is estimated to have ranged  between $60 billion and $225 billion between December 2018 and  October 2019.

As of November 2019, Coinbase, a large U.S.-based cryptocurrency  exchange, reports a user base of more than 30 million.

According to economists at the Federal Reserve Bank of New York, a  2018 survey they conducted found that 85 percent of respondents had  heard of cryptocurrencies, 5 percent currently or previously owned  cryptocurrency, and 15 percent reported that they were considering  buying cryptocurrency.

Federal agencies, including CFTC, FinCEN, and SEC, have jurisdiction  over various aspects of virtual currency markets and market participants.  In May 2014, we reported on the federal financial regulatory and law  enforcement agency responsibilities related to the use of virtual  currencies and their associated challenges. These challenges include  money laundering, transfers of funds across borders, and consumer and  investor protection issues. We also reported on the regulatory complexity  for virtual currencies and the approaches that federal and state regulators  have taken to their regulation and oversight. For example, CFTC has  taken the position that bitcoin and ether, another virtual currency, meet  the definition of a commodity provided in the Commodity Exchange Act.  SEC has determined that some virtual currencies may be designated as  securities, based on the characteristics of how they are offered and  sold. FinCEN determined that certain virtual currency businesses would  be money transmitters under the Bank Secrecy Act, subject to regulation  as money services businesses.

According to IRS guidance, convertible virtual currencies—which have an  equivalent value in real currency or act as a substitute for real currency— are to be treated as property for tax purposes. Among other things, this  classification means that income, including gains, from virtual currency  transactions is reportable on taxpayers’ income tax returns. Therefore, a  payment for goods or services made using virtual currency may be  subject to tax to the same extent as any other payment made in property.  Figure 2 illustrates examples of how virtual currency transactions can  affect taxes.

Taxpayers using virtual currency must keep track of transaction-level  information, such as the fair market value of the virtual currency at the  time it was obtained, to determine tax basis and calculate gains or losses.  The gain or loss from the sale or exchange of virtual currency is  characterized as either a capital gain or loss or an ordinary gain or loss,  depending on whether the virtual currency is held as a capital asset.

Taxpayers are required to report their gains or losses from virtual  currency on their tax returns, including Form 1040, U.S. Individual Income  Tax Return, and Form 8949, Sales and Other Dispositions of Capital  Assets, for capital gains or losses. Figure 3 shows one example of how  using virtual currencies could result in a capital gain or loss.

Data on Tax Compliance for Virtual Currencies Are Limited Tax and Information Returns Do Not Specifically Capture Information on Virtual Currency Income and Transactions

IRS has limited data on tax compliance for virtual currency use, partly  because the forms taxpayers use to report their taxable income do not  require them to identify whether the source of their income is from virtual  currency use. Likewise, information returns that third parties, such as  employers, financial institutions, or other entities, file to report taxpayer  income or transactions do not include space for, or direction to, indicate if  the income or transactions reported involved a virtual currency.

In 2016, the Treasury Inspector General for Tax Administration (TIGTA)  found that IRS had not developed a methodology for gathering data on  virtual currency use in taxable transactions that would help to analyze the  risk of noncompliance and to estimate its significance. TIGTA  recommended that IRS revise third-party information returns to identify  the amounts of virtual currency used in taxable transactions. IRS agreed  with the recommendation, but stated that it faced other higher priority  funding needs, and did not consider modifying information reporting forms  to be a priority at the time. As of February 5, 2020, IRS has not  implemented any changes to these information returns to include  information about virtual currency use.

However, IRS added a question about virtual currency to Schedule 1,  Additional Income and Adjustments to Income, of Form 1040 for tax year  2019. Individual taxpayers use Schedule 1 to report additional income,  such as capital gains, unemployment compensation, prize or award  money, and gambling winnings. IRS added a question asking if taxpayers  received, sold, sent, exchanged, or otherwise acquired any financial  interest in any virtual currency during the tax year. Only taxpayers who  are otherwise required to file Schedule 1 or who would answer “yes” to  the question need to file this schedule. According to IRS officials  responsible for examining tax returns, IRS’s focus is on ensuring  taxpayers are reporting all of their taxable income and it is not necessary  to distinguish between virtual currency transactions and other property  transactions being reported.

IRS Has Data on a Small Number of Taxpayers

Because IRS forms have not required taxpayers to explicitly identify  income from virtual currency, IRS uses data from other sources to inform  compliance decisions and research. These sources include:

Searches of tax return databases. For tax years 2013 to 2015, IRS  searched electronically filed Forms 8949 to identify how often  taxpayers included language in the property description to indicate the  transaction likely involved bitcoin, the most widely traded virtual  currency at the time. For the 3 years, IRS identified fewer than 900  taxpayers who reported virtual currency activity each year. IRS  officials said that due to the time and resources required to generate  these data, IRS did not generate these filing statistics for tax years  2016 or later. By comparing these data to the size of the bitcoin  market, IRS concluded that many taxpayers were likely not reporting  income from virtual currency use.

Third party information reports. To address tax noncompliance  risks for virtual currencies, in December 2016, IRS served a John Doe  summons to Coinbase, a U.S.-based cryptocurrency exchange.  After IRS later narrowed the scope of the summons, it requested  identifying and transactional data for all Coinbase users with a U.S.  address, U.S. telephone number, U.S. email domain, or U.S. bank  account that transacted with Coinbase between January 1, 2013, and  December 31, 2015 that had the equivalent of $20,000 in any one  transaction type (a buy, sell, send, or receive) in any year during that  period. According to an announcement posted on Coinbase’s website,  on February 23, 2018, Coinbase notified approximately 13,000  customers that it expected to deliver information about their accounts  to IRS within 21 days. In addition, IRS officials stated that IRS had  received information returns from a small number of virtual currency  exchanges for tax year 2017.

Third-party reports of potential fraud. IRS also has access to  information on potential fraud reported to IRS and FinCEN by third  parties. Financial institutions and money services businesses, which  could include virtual currency exchanges, are to file a Suspicious  Activity Report (SAR) if they observe or identify suspicious financial  activity. SAR reporting can help IRS in identifying potential income  underreporting, money laundering, and other potential tax-related  violations and crimes. IRS may also receive information about tax  noncompliance involving virtual currencies from whistleblowers and  other referral programs.

Voluntary disclosures by taxpayers. In March 2019, IRS updated  Form 14457, Voluntary Disclosure Practice Preclearance Request  and Application, to include a space specifically for taxpayers to  disclose that they have unreported virtual currency income. IRS’s  Criminal Investigation division (CI) reviews the forms IRS receives to  ensure they meet criteria of eligibility and timeliness, and that the  disclosure does not apply to illegal sources of income. CI sends forms  that meet the criteria to two of IRS’s civil operating divisions—Large  Business & International (LB&I) and Small Business/Self-Employed  (SB/SE)—for review. According to IRS officials, the addition of  virtual currency to the form was made to assist IRS employees in  routing the forms to the correct subject matter experts in the civil  operating divisions.

IRS Included Virtual Currencies in Research Projects

According to officials with IRS’s Research, Applied Analytics, and  Statistics (RAAS) division, RAAS had begun some virtual currency  research projects to better understand virtual currency tax compliance.  One project, which RAAS completed, was to develop compliance profiles  for taxpayers that LB&I had identified through its compliance efforts as  having virtual currency activity. RAAS officials also said that they are  enhancing their use of a range of third-party information reporting,  including reporting of virtual currency activity, to improve IRS’s ability to  assess compliance risks. These efforts focus on use of data from multiple  sources to better understand evolving risks and improve estimates of  compliance risk. These projects support LB&I, SB/SE, CI, and IRS’s  broader research, analysis, and statistical reporting needs.

Virtual currency has not been included in past National Research  Programs (NRP)—IRS’s detailed study of voluntary tax compliance used  as the basis for tax gap estimates. The most recent NRP study of  individual tax returns was tax years 2011-2013, before virtual currencies  became more widely used. RAAS officials said the time frame for the next  NRP study of individual tax returns has not yet been determined, but  virtual currency may be included in future NRP projects.

IRS Has Taken Some Steps to Address Virtual Currency Compliance Risks and Has Shared Information across Multiple Agencies

IRS Has Trained Staff on Virtual Currency and Begun Civil Enforcement Activities

In December 2013, IRS established the Virtual Currency Issue Team  (VCIT) to study virtual currencies and related compliance issues.  According to IRS officials, the VCIT aimed to learn about virtual  currencies, educate examiners about them, and develop examination  techniques to identify and address virtual currency tax compliance risks.  In 2015, the VCIT provided two training lessons for examiners on the  terminology, technology, and audit issues related to virtual currencies.  The VCIT is made up of about 30 individuals and continues to meet  periodically to discuss virtual currency issues.

In July 2018, IRS announced the launch of a virtual currency compliance  campaign within LB&I to address noncompliance related to individual  taxpayers’ use of virtual currency through multiple education and  enforcement actions, including outreach and examinations. The goals of  the compliance campaign include identifying causes of noncompliance  using feedback from examination results, using information to identify  additional enforcement approaches to increase compliance and decrease  taxpayer burden, and improving examiner knowledge and skills as related  to virtual currency transactions. According to IRS officials, the compliance  campaign was initiated, in part, to analyze large amounts of data received  from third-party sources.

As part of the campaign, IRS developed and delivered several online and  in-person training classes on blockchain technology and virtual currencies  to its examiners and other staff. The trainings included details on how to  identify and understand blockchain transactions and provide examiners  with information on how to seek additional information from taxpayers  about possible virtual currency use. According to LB&I officials, as  examiners provide feedback on what new issues they are seeing in cases  involving virtual currency, they will schedule follow-up training sessions to  address these new issues.

LB&I has also reached out to a number of external stakeholder groups to  gather information and better understand the tax concerns within the  virtual currency community. For example, LB&I and the IRS Office of  Chief Counsel have spoken to tax practitioner groups, state tax  authorities, IRS Nationwide Tax Forum participants, and tax preparation  software companies. According to IRS officials, the discussions they  had with tax preparation software companies led to some adding  questions to their programs asking taxpayers to enter virtual currency  income when preparing their tax returns.

The compliance campaign also aims to assist in developing a  comprehensive IRS virtual currency strategy. In addition to leading the  compliance campaign, LB&I is also leading a working group focused on  cryptocurrency that includes members from across IRS, including LB&I,  SB/SE, CI, and the Office of Chief Counsel. This working group reports to  the IRS Enforcement Committee, which includes the Deputy  Commissioner for Services and Enforcement and the commissioners for  each of the operating divisions and CI.

CI has been assisting in analyzing data received from third-party sources  to look for potential investigative leads. According to CI officials, CI first  reviews the data to identify any taxpayers who are already targets of CI  investigations so that LB&I does not use the information in its civil  enforcement efforts. The officials also said that they were reviewing  information from large virtual currency users to identify any ties to criminal  activity. However, according to IRS officials, since some of the data IRS  has received predate a major uptick in virtual currency activity in 2017,  the data that predate these developments are less valuable than more  recent data would be, other than to understand the history of an  individual’s virtual currency usage.

IRS has also begun civil enforcement activities to address virtual currency  noncompliance as part of the compliance campaign. In April 2019, LB&I  was forwarding cases identified as likely involving virtual currency for  examination classification, the process IRS uses to determine which  returns to select to examine. Due to the time needed to complete  examinations and to allow taxpayers time to exercise their rights, IRS  officials said they do not have outcome data from these efforts yet.

In July 2019, IRS began sending out more than 10,000 letters to  taxpayers with virtual currency transactions. These letters stated that IRS  is aware that the taxpayer may have a virtual currency account. They  instructed the taxpayer to ensure that virtual currency income, gains, and  losses have been reported appropriately and to file or amend returns as  necessary. The letters also provide taxpayers with information on where  they can find resources to help them understand their reporting  obligations.

IRS Shares Information across Multiple Agencies, Focusing on Criminal Enforcement Efforts That Can Involve Virtual Currencies

According to IRS officials, CI works with a number of federal partners,  including FinCEN and the Federal Bureau of Investigation (FBI), among  others, in the routine course of its work, which may involve virtual  currency issues. According to CI officials, virtual currency does not  constitute a new program area that would require a new specific set of  policies and procedures. Instead, traditional crimes that CI might  investigate may be intertwined with virtual currency use.

CI participates in virtual currency issue information sharing efforts through  a number of groups. For example, CI is a monthly participant in the FBI’s  National Cyber Investigative Joint Task Force, which brings agencies  together to share intelligence and work large-scale cases jointly. CI also  has agents on site at the National Cyber-Forensics and Training Alliance,  a public-private partnership, and at the European Union Agency for Law  Enforcement Cooperation. Both entities work on a variety of issues,  including virtual currency issues.

CI also participates in some multinational information sharing groups to  address virtual currency issues as part of its broader criminal  enforcement goals. For example, CI participates in the Joint Chiefs of  Global Tax Enforcement (J5), a group of criminal intelligence and tax  officials from Australia, Canada, the Netherlands, the United Kingdom,  and the United States that launched in mid-2018 to focus on shared  cross-national tax risks, including cybercrimes and virtual currency.  Among the goals of the J5 are to lead the international community in  developing a strategic understanding of offshore tax crimes and  cybercrimes, and raise international awareness that the J5 are working  together to address international and transnational tax crimes.

Within the Department of the Treasury (Treasury), IRS works with  Treasury’s Office of Tax Policy when developing any guidance or  regulation, including for virtual currency. IRS also works with FinCEN with  regard to IRS’s delegated authority to administer parts of the Bank  Secrecy Act, including Report of Foreign Bank and Financial Accounts  (FBAR) filings. For example, FinCEN provides training materials to  SB/SE examination staff who may come across virtual currency issues in  the performance of a Bank Secrecy Act examination. IRS and FinCEN  officials also periodically discuss how to apply the Bank Secrecy Act and  its implementing regulations to virtual currency transactions.

Given IRS’s unique role in administering the federal tax system, it  generally does not need to coordinate with other agencies outside of  Treasury in developing or issuing virtual currency guidance or taking civil  enforcement actions. According to IRS officials, the work of the virtual  currency compliance campaign does not involve any other federal  agencies.

IRS’s Virtual Currency Guidance Meets Some Taxpayer Needs, but IRS Did Not Address Applicability of Frequently Asked Questions IRS First Issued Virtual Currency Guidance in 2014 and Solicited Public Input to Identify Additional Guidance Needs

IRS first issued virtual currency guidance in 2014, in response to our  recommendation. In 2013, we found that IRS had not issued guidance  specific to virtual currencies and that taxpayers may be unaware that  income from transactions using virtual currencies could be taxable. We  recommended that IRS provide taxpayers with information on the basic  tax reporting requirements for transactions using virtual currencies. In  response to this recommendation, IRS issued Notice 2014-21 in March  2014 and published it in the Internal Revenue Bulletin (IRB) in the form of  answers to frequently asked questions (FAQs).

IRS solicited public input on Notice 2014-21 through several means.  Within the notice, IRS requested comments from the public regarding  other aspects of virtual currency transactions that should be addressed in  future guidance by providing a physical and email address to which  comments could be submitted. IRS reviewed more than 200 public  comments it received to identify topics that were in need of further  guidance. Our analysis of the public comments found that the most  common topics concerned tax forms and reporting (64 comments),  realization of income (45 comments), cost basis (33 comments), and  general tax liability (29 comments). Other topics included the tax  implications of hard forks and airdrops, mining, and foreign reporting.

Virtual currency stakeholders we spoke with, such as tax practitioners,  executives at virtual currency exchanges, advocacy groups, and industry  representatives also identified these topics as in need of further guidance.  Additionally, LB&I officials said they held several sessions to gather  information from external stakeholders, such as tax practitioner groups  and state tax authorities, to develop a better understanding of what was  happening in taxpayer communities.

IRS’s 2019 Virtual Currency Guidance Answers Some Taxpayer Concerns, but Presents Additional Challenges for Taxpayers

In October 2019, IRS issued two forms of additional virtual currency  guidance, which answered some questions previously raised by the  public comments and virtual currency stakeholders. According to IRS,  these guidance documents were intended to supplement and expand  upon Notice 2014-21.

Revenue Ruling 2019-24 addresses the tax treatment of hard forks  and airdrops following hard forks. Specifically, the guidance  discusses whether taxpayers have gross income as a result of (1) a  hard fork, if they do not receive units of a new virtual currency; or (2)  an airdrop of a new virtual currency following a hard fork if they  receive units of new virtual currency.

Additional FAQs provide further examples of how tax principles apply  to virtual currency held as a capital asset. Topics addressed include  what tax forms to use when reporting ordinary income and capital  gains or losses from virtual currency; how to determine fair market  value of virtual currencies; when virtual currency use results in taxable  income; how to determine cost basis in several scenarios; and when a  taxpayer may use the First-In-First-Out accounting method, known as  FIFO, to calculate their gains.

However, some virtual currency and tax stakeholders with whom we  spoke expressed concern that the 2019 revenue ruling and FAQs leave  many questions unanswered and provide confusing responses to others.  Their concerns include the following:

Clarity: According to some stakeholders, Revenue Ruling 2019-24 is  unclear, mostly due to confusion surrounding IRS’s usage of technical  virtual currency terminology and the situations meant to illustrate  IRS’s application of the law to hard forks and airdrops. Several tax  and virtual currency stakeholders we spoke with said these examples  do not accurately explain how virtual currency technology works and  therefore may not be helpful to taxpayers looking for guidance on the  tax implications of income received as a result of hard forks or  airdrops. In public remarks on the new guidance in October 2019,  IRS’s Chief Counsel stated that terms are not used in a uniform way  in the virtual currency industry, but IRS is interested in receiving  comments on how virtual currency technology should be described.

Additional topics in need of guidance: The revenue ruling and  additional FAQs do not address several topics raised in the public  comments and by stakeholders. For example, the guidance does not  clarify foreign asset reporting requirements for virtual currency. The  statutory provisions commonly known as the Foreign Account Tax  Compliance Act (FATCA) require taxpayers and foreign financial  institutions to report on certain financial assets held outside the United  States. Regulations implementing the Bank Secrecy Act separately  require taxpayers to report certain foreign financial accounts to  FinCEN on the FBAR form. Some practitioners told us that it is  unclear whether these requirements apply to virtual currency wallets  and exchanges, as we discuss later in this report. Other topics not  addressed in the 2019 guidance include mining, like-kind exchanges,  and retirement accounts.

According to an official from the IRS Office of Chief Counsel, IRS’s focus  when developing the 2019 guidance was to assist individual  taxpayers. Therefore, the topics addressed by the revenue ruling and  FAQs were limited to the most common issues that would be applicable  to most individual taxpayers. The official told us that if IRS were to  develop additional virtual currency guidance in the future, it may focus on  a different audience, such as taxpayers involved in virtual currency  businesses or exchanges that could be subject to third-party information  reporting. Another official stated that issuing guidance on certain topics,  including like-kind exchanges, would have taken additional time, and  these topics were therefore left unaddressed.

IRS Did Not Include That the 2019 FAQs Are Not Legally Binding

IRS issues thousands of publications in a variety of different forms to help  taxpayers and their advisors understand the law; however, IRS has stated  that only guidance published in the IRB contains IRS’s authoritative  interpretation of the law. Unlike with the virtual currency FAQs IRS  issued in 2014 in the form of a notice, the 2019 FAQs were not published  in the IRB. Therefore, the 2019 FAQs are not binding on IRS, are subject  to change, and cannot be relied upon by taxpayers as authoritative or as  precedent for their individual facts and circumstances. For FAQs not  published in the IRB, tax practitioners have noted that sometimes IRS has  included a disclaimer noting that the FAQs do not constitute legal  authority and may not be relied upon. The new virtual currency FAQs do  not include such a disclaimer.

According to IRS officials, they did not include a disclaimer along with the  new FAQs because the FAQs do not contain any substantial new  interpretation of the law. IRS officials did not feel that a disclaimer about  the limitations of the FAQs was necessary or that it would be helpful to  taxpayers. However, the FAQs provide new information, such as a  definition of the term “cryptocurrency” and an explanation of how  taxpayers can track cost basis for virtual currency.

As we have previously reported, clarity about the authoritativeness of  certain IRS publications could be improved by noting any limitations,  especially when FAQs provide information to help taxpayers comply with  tax law. Additional explanatory language would help taxpayers  understand what type of IRS information is considered authoritative and  reliable as precedent for a taxpayer’s individual facts and circumstances.

The first article in IRS’s Taxpayer Bill of Rights—“The Right to Be  Informed”—states that taxpayers have the right to know what they need  to do to comply with tax laws. The article further states that taxpayers are  entitled to clear explanations of the laws and IRS procedures in all forms,  instructions, publications, notices, and correspondence. As we have  previously reported, just as taxpayers have the right to clear explanations  in IRS instructions and publications, taxpayers should be alerted to any  limitations that could make some IRS information less authoritative than  others.

Failing to note any limitations associated with particular guidance could  lead to misinterpretation of nonauthoritative information from IRS. If  taxpayers make decisions based on guidance that is nonauthoritative,  including FAQs, those taxpayers’ confidence in IRS and the tax system  could be undermined if the content is later updated and IRS challenges  taxpayers’ positions. As we have noted in prior reports, taxpayers’  perception that IRS is fairly and uniformly administering the tax system  helps further overall voluntary compliance and lowers IRS’s administrative  costs.

Third-Party Information Reporting on Virtual Currency Is Limited, and Foreign Account Reporting Requirements Are Unclear

Limited Third-Party Information Reporting Makes It Difficult for IRS to Address Compliance Risks

IRS does not receive information returns on some potentially taxable  transactions involving virtual currency, which limits its ability to detect  noncompliance. Some virtual currency exchanges send information  returns to IRS and to customers that provide information about  customers’ trading activity, but others do not.

Financial institutions and other third parties are to report interest  payments, property sales, and other transactions to both taxpayers and  IRS using forms known as information returns.

Form 1099-K, Payment Card and Third Party Network  Transactions. Third parties that contract with a substantial number of  unrelated merchants to settle payments between the merchants and  their customers are required to issue a Form 1099-K for each  merchant that meets the threshold of having more than 200  transactions totaling more than $20,000 in a year.

Form 1099-B, Proceeds from Broker and Barter Exchange  Transactions. Brokers use Form 1099-B to report transactions such  as sales or redemptions of securities, regulated futures contracts, and  commodities. For certain types of property, brokers must also report  cost basis information on Form 1099-B if the information is required.

Form 1099-MISC, Miscellaneous Income. Certain payments made  in the course of a trade or business—including rents, prizes, and  various other types of income—must be reported by the payer on  Form 1099-MISC. For most types of income subject to reporting on  Form 1099-MISC, payers must file the form only if they made  payments totaling at least $600.

According to our review of websites for nine major U.S.-based virtual  currency exchanges, as of November 2019, two exchanges have policies  posted online stating that they report information for some of their  customers’ virtual currency transactions to IRS on Form 1099-K. One  exchange states that it reports customers’ transactions on Form 1099-B,  a more detailed information return that provides a breakdown of individual  virtual currency transactions. Another exchange’s website states that it  provides Forms 1099, but does not identify the form more specifically.  Three exchanges’ websites have policies stating that the exchanges do  not report customers’ transactions on tax forms. The remaining two  exchanges do not state on their websites whether or not they file  information returns or provide customers with tax forms.

When transactions handled by third parties, such as virtual currency  exchanges, go unreported on information returns, it is difficult for IRS to  identify and address compliance risks. According to IRS officials and tax  practitioners we interviewed, it is difficult for IRS to find out when taxable  transactions involving virtual currency are occurring. As discussed earlier  in this report, IRS’s virtual currency compliance campaign has identified  more than 10,000 taxpayers who may not have properly reported virtual  currency transactions on tax returns. However, the campaign likely has  not identified all taxpayers with underreported virtual currency income. In  addition, according to IRS officials, examining tax returns is more  resource intensive than the automated processes IRS uses to match tax  returns against information returns.

For taxpayers, limited information reporting by third parties can make it  difficult to complete tax returns. Tax practitioners told us that  recordkeeping is a challenge for taxpayers who buy and sell virtual  currencies. To report virtual currency income accurately under IRS  guidance, taxpayers need to report information about each transaction,  including cost basis and fair market value at the time virtual currency is  disposed of, such as by selling it for cash or another virtual currency on  an exchange.

Some taxpayers may not keep their own records of virtual currency  transactions, and as a result may lack easy access to the information that  would be provided in third-party information returns. When taxpayers do  keep these records, they may not know how to report virtual currency  transactions on tax forms. As discussed earlier in this report, 64 of the  public comments IRS received on Notice 2014-21 were about forms and  reporting. For example, some of these 64 comments expressed  uncertainty about how to calculate the fair market value of virtual currency  at the time of sale; others requested assistance in determining which tax  forms to use to report income from virtual currency transactions.

Some virtual currency transactions are not subject to third-party reporting  requirements. For example, unless owned by a U.S. payor (including a  controlled foreign corporation), virtual currency exchanges operating  outside the United States are not required to file information returns such  as Forms 1099-K or 1099-B unless the customer or transaction has  certain connections to the United States. Some transactions, such as  transferring virtual currency directly to a merchant in exchange for goods,  generally create no obligation to file any information returns.

Other virtual currency transactions, such as sales of virtual currency for  cash through virtual currency exchanges, may be subject to third-party  reporting requirements. However, those requirements are not entirely clear, and people have interpreted them differently. Tax practitioners we  spoke with generally stated that it is not clear whether current regulations  require virtual currency exchanges to report customers’ trading activity on  Forms 1099-K or 1099-B. According to IRS officials, virtual currency  exchanges may be subject to the 1099-K reporting requirement if they fall  into the legal category of “third party settlement organizations.”  Exchanges are subject to the 1099-B requirement only if they are brokers  or barter exchanges. IRS does not have an official position on whether  virtual currency exchanges are required to report customers’ trading  activity on Form 1099-B. There may also be ambiguity regarding when, if  at all, reporting on virtual currency sales is required on Form 1099-MISC.

Furthermore, even if exchanges are subject to the 1099-K, 1099-B, or  1099-MISC reporting requirements, these requirements do not cover all  taxable transactions. Third-party settlement organizations are required to  file Form 1099-K only for customers who make more than 200  transactions in a year that total more than $20,000. Taxable transactions  below that threshold may not be reported. Separately, some transactions  carried out by brokers do not need to be reported on Form 1099-B unless  they involve cash. For example, taxpayers must report trades between  different virtual currencies on tax returns, but brokers may not be required  to report such trades on Form 1099-B. According to IRS, a virtual  currency exchange would be required to file Form 1099-MISC if it has  sufficient information, such as the recipient’s basis in the virtual currency,  to determine whether a payment made to a recipient in exchange for  virtual currency gives rise to income for that recipient.

In addition, Forms 1099-K, 1099-B, and 1099-MISC do not always  contain all the information that taxpayers need to file accurate tax returns  or that IRS needs to monitor compliance. Form 1099-K provides  information on the number and gross amount of payments made to the  recipient, but does not provide information about individual transactions.

Some tax practitioners we interviewed stated that taxpayers who receive  Form 1099-K for virtual currency transactions may find the form unhelpful  or confusing. Because the form does not identify specific transactions, it  may be difficult to match the aggregate amounts reported on the form  with taxpayers’ own records of virtual currency transactions. Form 1099-B  does provide information about individual transactions, but does not  always include or require cost basis information. According to IRS, a  Form 1099-MISC that reports a payee’s gain does not provide information  about that payee’s gross proceeds and basis.

Some stakeholders we interviewed mentioned challenges that could  make it difficult to implement information reporting at the individual  transaction level. For example, it could be difficult to distinguish between  taxable dispositions of virtual currency—such as the sale of virtual  currency for U.S. dollars—and nontaxable events such as the transfer of  virtual currency from a taxpayer’s account on an exchange to a personal  wallet controlled directly by the same taxpayer. These stakeholders also  told us that if exchanges were required to report cost basis information,  additional challenges could include tracking the cost basis of virtual  currency transferred between exchanges. However, as we have  previously reported, cost basis reporting can be particularly valuable for  tax compliance. IRS officials told us that they are studying the issue of  third-party information reporting, and it is included in IRS’s priority  guidance plan as of October 2019.

We have reported that, in general, the extent to which taxpayers  accurately report their income is closely aligned with the amount of  income that third parties report to them and to IRS. For example,  according to IRS data for tax years 2011-2013, taxpayers misreported  more than half of their income for types of income subject to little or no  third-party information reporting (see figure 4). Taxpayers misreported a  much lower percentage of their income for types of income subject to at  least some information reporting.

Information returns that include details about individual transactions can  assist taxpayers by providing information about how to report virtual  currency income correctly. For example, in addition to providing  transaction details, Form 1099-B instructs recipients where to report  transactions on Form 8949 or Schedule D, which are forms used to report  capital gains. By contrast, Form 1099-K does not include similar  instructions.

One of IRS’s strategic goals is to protect the integrity of the tax system by  encouraging compliance through administering and enforcing the tax  code. This goal includes identifying and planning for compliance risks  proactively, including risks associated with the increasing complexity of  the tax base. Further, internal control standards state that management  should use quality information to achieve the entity’s objectives. Using  quality information requires identifying information requirements and  obtaining relevant data from reliable sources.

As discussed above, IRS does not have quality information on many  potentially taxable transactions involving virtual currency, in part because  information reporting requirements for virtual currency exchanges are  unclear, and in part because some information reporting does not include  detailed information about specific transactions. As a result, some  taxpayers may not be reporting virtual currency transactions properly on  their tax returns or paying the full amount of tax owed on those  transactions, contributing to the tax gap.

IRS and FinCEN Have Not Clarified Whether Foreign Account Reporting Requirements Apply to Virtual Currency

As previously discussed, two overlapping reporting requirements apply to  taxpayers who have foreign financial assets. These two requirements are  the Report of Foreign Bank and Financial Accounts (FBAR) filings  required under the Bank Secrecy Act and the separate reports required  by the statutory provisions commonly known as the Foreign Account Tax  Compliance Act (FATCA). The federal agencies that administer these  requirements have not clarified how taxpayers who hold virtual currency  should interpret them.

Under FATCA, taxpayers have an obligation to report certain foreign  financial accounts and other assets on IRS Form 8938, Statement of  Specified Foreign Financial Assets, if the value of those assets exceeds a  certain amount. FATCA was enacted in 2010 to reduce offshore tax  evasion, and it also requires foreign financial institutions to report detailed  information to IRS about their U.S. customers.

Tax practitioners we interviewed told us that there is no generally  accepted view about whether FATCA filing requirements apply to virtual  currency holdings, and IRS has not publicly stated a position on how, if at  all, FATCA requirements apply to virtual currency holdings for either  taxpayers or institutions. Some practitioners stated that in the absence of  guidance or information from IRS specifically addressing virtual currency  and FATCA, some of their clients report foreign virtual currency accounts  because the potential penalties for failing to report, if deemed to be  required, are high. Additionally, several public comments on IRS Notice  2014-21 requested clarification from IRS about whether virtual currency  holdings must be reported under FATCA.

The FATCA filing requirements can be difficult for individual taxpayers to  interpret, in part because FATCA was enacted before the use of virtual  currency became more widespread, and it was not designed to cover  nontraditional assets such as virtual currencies. For example, under  FATCA, taxpayers must report accounts at foreign financial institutions. A  taxpayer who holds virtual currency with an exchange based outside the  United States may not know whether the exchange counts as a foreign  financial institution under FATCA because this determination involves  applying legal criteria to specific facts about how the exchange  operates.

Taxpayers must also report foreign nonaccount assets held for  investment (as opposed to held for use in a trade or business), such as  foreign stock and securities, foreign financial instruments, contracts with  non-U.S. persons, and interests in foreign entities. IRS officials told us  that in some situations, virtual currencies could be foreign nonaccount  assets, depending on specific facts about how an individual taxpayer  holds the virtual currency. However, a taxpayer holding virtual currency  may not know whether the virtual currency is considered a specified  foreign financial asset because this determination involves applying legal  criteria to specific facts such as whether the virtual currency has a foreign  issuer, which the taxpayer may not have sufficient information to  determine.

According to IRS officials, they have not issued guidance about virtual  currency and FATCA because the instructions for Form 8938 clearly  explain how taxpayers are to interpret FATCA requirements. However,  those instructions do not mention virtual currency and do not provide  information needed to determine whether virtual currency holdings must  be reported. For example, the instructions state that a financial account is  any depository or custodial account maintained by a foreign financial  institution, but do not explain under what circumstances, if any, an  account that holds virtual currency could be considered a depository or  custodial account.

IRS’s Taxpayer Bill of Rights states that taxpayers are entitled to clear  explanations of the laws and IRS procedures in all tax forms, instructions,  publications, notices, and correspondence. Furthermore, one of IRS’s  strategic goals is to empower taxpayers by making it easier for them to  understand and meet their filing, reporting, and payment obligations.

Without information about how to interpret and apply FATCA  requirements to situations involving virtual currency, taxpayers will not  know whether they are required to report virtual currency held outside the  United States. As a result, they may be underreporting, depriving IRS of  data needed to address offshore tax evasion, or overreporting by filing  forms that are not required. As we have previously reported, such  overreporting creates unnecessary burdens, including financial costs, for  taxpayers.

Separate from the requirement to file Form 8938 under FATCA,  regulations implementing the Bank Secrecy Act require reporting of  financial accounts maintained with financial institutions located outside  the United States on the FBAR form. FinCEN’s FBAR regulations  predate the widespread use of virtual currency and do not specifically  mention virtual currency. Consequently, tax practitioners have raised  questions about whether taxpayers are required to include virtual  currency holdings in FBAR filings.

In correspondence and interviews, FinCEN officials have stated that,  based on their understanding of the regulations, virtual currency does not  need to be reported on the FBAR. For example, FinCEN officials told us  that FinCEN provides a standard response when members of the public  ask FinCEN’s Resource Center about reporting virtual currency on the  FBAR. The response states, in part, “as of right now, reporting [virtual  currency exchange accounts] on the FBAR is not required.” Likewise, in  March 2019, FinCEN responded in writing to a question from the  American Institute of Certified Public Accountants by stating that the  FBAR regulations do not define virtual currency held in an offshore  account as a type of reportable account.

While FinCEN has provided responses to direct questions, it has not  made information about whether foreign virtual currency accounts are  subject to the FBAR requirement readily available, such as by posting this  information on its website. FinCEN officials stated that FinCEN and IRS  had issued a statement on IRS’s website in 2014 informing the public that  virtual currencies did not need to be reported on the FBAR. However,  the officials noted that the statement was no longer available on the  website, but they did not say when it may have been removed or why.  Neither IRS’s FBAR Reference Guide nor FinCEN’s instructions for filing  the FBAR mention virtual currencies.

Internal control standards state that management should externally  communicate the necessary quality information to achieve the entity’s  objectives. As part of this standard, management should communicate  information that allows external parties, including the general public, to  assist the entity in achieving its objectives.

In the absence of a readily available official statement from FinCEN that  virtual currencies are not reportable on the FBAR, users of virtual  currency may be filing reports that are not legally required. According to  some tax practitioners we interviewed, some individuals may report  foreign virtual currency accounts on the FBAR even if they believe it is  unlikely that they are required to report, because of the high penalties for  failing to file required FBARs. Such filings can create financial costs and  unnecessary recordkeeping and other burdens for these individuals.

Virtual currencies can present challenges for enforcement of tax laws,  both because they can be circulated without a central authority and  because complying with current tax requirements can be confusing and  burdensome. IRS has taken important steps to address these challenges,  including issuing multiple sets of guidance to clarify how virtual currencies  would be treated for tax purposes and carrying out a range of  enforcement activities to address noncompliance.

Although IRS’s 2019 virtual currency guidance addressed some issues  left unresolved by its 2014 guidance, it did not address others, and it has  also prompted new concerns among virtual currency stakeholders.  Additionally, including information that the 2019 FAQs are not legally  binding would enhance taxpayer understanding and could ultimately help  enhance taxpayers’ confidence in IRS and the tax system.

Currently, much trading activity in virtual currency goes unreported on  information returns. In part, this lack of reporting may be because third  parties are unclear about whether they are required to report. Limitations  in what information returns report related to virtual currencies also  constrain the utility of reported information. In general, information  reporting is associated with high levels of compliance.

Additionally, the rules for foreign asset reporting—specifically, the FBARs  required by the Bank Secrecy Act and the separate reports required by  FATCA—do not clearly address virtual currency, and tax professionals  have raised questions about the applicability of these requirements to  virtual currency. Clarifying the FATCA requirements and making a  statement about the FBAR requirements readily available to the public  would help reduce uncertainty about these rules and may result in  reduced burden for some taxpayers who may be filing reports that are not  required.

We are making a total of four recommendations, including three to IRS  and one to FinCEN. Specifically,  The Commissioner of Internal Revenue should update the FAQs issued in  2019 to include a statement that the FAQs may serve as a source of  general information but cannot be relied upon by taxpayers as  authoritative since they are not binding on IRS. (Recommendation 1)

The Commissioner of Internal Revenue should take steps to increase  third-party reporting on taxable transactions involving virtual currency,  which could include clarifying IRS’s interpretation of existing third-party  reporting requirements under the Internal Revenue Code and Treasury  Regulations, or pursuing statutory or regulatory changes.  (Recommendation 2)

The Commissioner of Internal Revenue should clarify the application of  reporting requirements under FATCA to virtual currency.  (Recommendation 3)

The Director of FinCEN, in coordination with IRS as appropriate, should  make a statement about the application of foreign account reporting  requirements under the Bank Secrecy Act to virtual currency readily  available to the public. (Recommendation 4)

We provided a draft of this report to IRS, FinCEN, Treasury, SEC, and  CFTC for review and comment. In its written comments, which are  summarized below and reproduced in appendix II, IRS agreed with one  and disagreed with two of the recommendations directed to it. In its  written comments, which are summarized below and reproduced in  appendix III, FinCEN agreed with the recommendation directed to it. IRS,  Treasury, SEC, and CFTC provided technical comments, which we  incorporated as appropriate.

IRS agreed with the recommendation to take steps to increase third-party  reporting on taxable transactions involving virtual currency  (recommendation 2). IRS stated that it is working with Treasury to  develop guidance on third-party reporting under section 6045 of the  Internal Revenue Code for certain taxable transactions involving virtual  currency. Such guidance, if it aims to increase third-party reporting, would  address the intent of the recommendation.

IRS disagreed with the recommendation to add a statement to the 2019  FAQs on virtual currency informing taxpayers that the FAQs provide  general information but are not binding on IRS (recommendation 1). IRS  stated that the FAQs are illustrative of how longstanding tax principles  apply to property transactions. IRS also stated that IRS does not take  positions contrary to public FAQs. We continue to believe that including  such a statement would provide more transparency and help taxpayers  understand the nature of the information provided in the FAQs.

As we state earlier in this report, IRS has included disclaimer statements  in other informal FAQs posted on its website. IRS could include a similar  statement in the virtual currency FAQs at minimal cost. Alternatively, if  IRS intends to be bound by the positions it takes in the current version of  the virtual currency FAQs, as the response to this recommendation  suggests, it could publish the FAQs in the Internal Revenue Bulletin.  Doing so would render a disclaimer statement unnecessary and would  satisfy the intent of the recommendation.

IRS disagreed with the recommendation to clarify the application of  FATCA reporting requirements to virtual currency (recommendation 3).  IRS stated that U.S. exchanges and other U.S. businesses play a  significant role in virtual currency transactions carried out by U.S.  taxpayers, and therefore it is appropriate for IRS to focus on developing  guidance for third-party reporting under section 6045, as discussed  above. IRS also stated that guidance on FATCA may be appropriate in  the future when the workings of foreign virtual currency exchanges  become more transparent.

We believe that, given the widespread uncertainty about the FATCA  requirements among virtual currency stakeholders, it would benefit  taxpayers for IRS to clarify these requirements to the extent possible with  the information currently available. It may be appropriate to wait for future  developments in the foreign virtual currency exchange industry before  issuing detailed, thorough guidance on this issue. However, IRS could  address the uncertainty about the FATCA requirements by clarifying in  general terms how it believes they should be interpreted in situations  involving virtual currency.

In its comments, FinCEN agreed with the recommendation to make a  public statement about whether virtual currency must be reported on the  FBAR (recommendation 4). FinCEN confirmed in its letter that as of  January 2020, its regulations do not require virtual currency held in an  offshore account to be reported on the FBAR. Additionally, FinCEN stated  that it will coordinate with IRS to determine the best approach to provide  clarity to the public regarding the FBAR requirement.

We are sending copies of this report to the appropriate congressional  committees, the Secretary of the Department of the Treasury, the  Commissioner of Internal Revenue, the Director of the Financial Crimes  Enforcement Network, the Chairman of the Securities and Exchange  Commission, the Chairman of the Commodity Futures Trading  Commission, and other interested parties. In addition, the report is  available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-9110 or mctiguej@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix IV.

Appendix I: Objectives, Scope, and Methodology

Our objectives were to (1) describe what is known about virtual currency  tax compliance; (2) describe the steps the Internal Revenue Service (IRS)  has taken to address virtual currency tax compliance risks; (3) evaluate  the extent to which IRS’s virtual currency guidance meets taxpayer  needs; and (4) evaluate whether additional information reporting could  assist IRS in ensuring compliance.

To describe what is known about virtual currency tax compliance and the  steps IRS has taken to address virtual currency tax compliance risks, we  reviewed IRS documentation on the agency’s virtual currency tax  enforcement efforts, including information about the legal summons IRS  issued to Coinbase and the Large Business and International (LB&I)  division’s virtual currency compliance campaign. We interviewed IRS  officials in the Small Business/Self Employed (SB/SE) and LB&I operating  divisions, as well as the Research, Applied Analytics, and Statistics  division about any data the agency had on virtual currency tax  compliance, challenges in collecting such data, and plans for data  analyses. We also reviewed IRS forms that taxpayers may use to report  virtual currency use.

We interviewed officials from the Financial Crimes Enforcement Network,  Commodity Futures Trading Commission, and Securities and Exchange  Commission about coordination efforts that have been made across  agencies regulating virtual currencies. We also interviewed tax  practitioners, tax attorneys, virtual currency industry advocates, and  virtual currency exchange executives about virtual currency tax  compliance issues. We took a snowball sampling approach to identify the  outside stakeholders we interviewed, which involved asking stakeholders  we interviewed for recommendations of others we should contact to gain  additional insight into virtual currency tax compliance, and we assessed  their qualifications and independence. In total, we interviewed five  individual stakeholders in addition to representatives of 10 entities with  expertise in tax issues related to virtual currency. Although results from  these interviews are not generalizable, they provide insight into what is  known about tax compliance and the steps IRS has taken to address  virtual currency tax compliance risks.

To evaluate the extent to which IRS’s virtual currency guidance meets  taxpayer needs, we identified and analyzed all of the guidance and  statements IRS has published about tax compliance for virtual currencies.  To identify these documents, we searched IRS’s website and interviewed  IRS officials. According to IRS officials, Notice 2014-21, issued in March  2014, and Revenue Ruling 2019-24 and Frequently Asked Questions  (FAQs), issued in October 2019, are the only IRS guidance specific to  virtual currencies.

We also reviewed and analyzed all of the public comments IRS had  received on Notice 2014-21 as of August 19, 2019, to determine the  concerns raised about virtual currency tax compliance. IRS sent us 229  public comments. We identified 25 of the comments as not applicable  because they were not related to Notice 2014-21, were duplicate  comments, or were otherwise not relevant. Two reviewers coded the  content of the 204 applicable public comments and grouped them into 13  different thematic categories. We developed these categories based on  the topics or issues that commenters identified. We assigned each  separate issue raised by a comment to an existing category unless it did  not relate to any of the existing categories, in which case we created a  new category. We also recorded the date the comment was submitted  and the occupation of the commenter, if specified in the comment.

To assess the reliability of these data, we reviewed relevant  documentation and consulted knowledgeable IRS officials. Specifically,  we requested information from IRS’s Office of Chief Counsel to identify  the quality controls in place to help ensure all comments are processed.  We determined that the data were sufficiently reliable for our purposes.  The information we obtained from these comments may not be  representative of the viewpoints of the entire U.S. public.

In addition, we interviewed the stakeholders mentioned above before IRS  released new guidance in October 2019 to identify any taxpayer  concerns, any compliance challenges with virtual currency tax obligations,  and the extent to which the guidance provided in IRS’s Notice 2014-21  was meeting taxpayer needs. We reached out to these same  stakeholders in October 2019, after IRS issued a new set of FAQs and  Revenue Ruling 2019-24, to determine how these new guidance  documents addressed taxpayers’ concerns. Of the five individuals and 10  groups we initially interviewed, we received responses regarding the new  IRS guidance from four individuals and six groups. The information we  obtained from these practitioners and exchanges is not generalizable to  all practitioners and exchanges because we took a snowball sampling  approach, but the information provides insight into the extent to which  IRS’s virtual currency guidance is meeting the needs of taxpayers.

To evaluate whether additional information reporting could assist IRS in  ensuring compliance, we reviewed IRS’s requirements for information  reporting for virtual currency transactions, including the laws and  regulations for foreign asset reporting. We interviewed IRS officials in the  SB/SE and LB&I operating divisions about how IRS’s third-party and  taxpayer information reporting processes and current forms assist in  IRS’s work to detect noncompliance for virtual currencies. We reviewed  the websites of a judgmental selection of nine virtual currency exchanges  for policies or statements about tax reporting, including whether the  exchanges file Forms 1099-B or 1099-K. For the website review, we  selected virtual currency exchanges that were based in the United States  and that were likely, because of their size or public profile within the  virtual currency industry, to have established policies regarding  information reporting. For each exchange, we identified and categorized  any statements on the exchange’s website regarding tax or information  reporting, such as a statement that the exchange does not provide any  tax forms to customers or a statement that the exchange provides  information on a specific form to customers and IRS.

We also interviewed the stakeholders mentioned above to determine  what information is being reported to IRS and whether additional  information reporting would help IRS and taxpayers with ensuring tax  compliance. We interviewed executives from two exchanges to determine  what burden, if any, information reporting does or could impose on  exchanges and virtual currency users. We attempted to contact four  additional exchanges but did not receive a response. Because we used a  snowball sampling approach, the information we obtained from these  virtual currency industry participants is not generalizable to all virtual  currency industry participants.

We conducted this performance audit from October 2018 to February  2020 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

Appendix II: Comments from the Internal Revenue Service

Appendix III: Comments from the Financial Crimes Enforcement Network

Appendix IV: GAO Contact and Staff Acknowledgments

In addition to the contact named above, Jeff Arkin (Assistant Director),  Danielle Novak (Analyst-in-Charge), Theodore Alexander, Michael  Bechetti, David Blanding, Jacqueline Chapin, Ed Nannenhorn, Bruna  Oliveira, Kayla Robinson, and Andrew J. Stephens made key  contributions to this report.

As virtual currencies like bitcoin grow in popularity, how can IRS be sure that people are paying relevant taxes?

IRS addressed some taxpayer questions in its 2014 and 2019 virtual currency guidance. For example, the guidance says that using virtual currency can produce taxable capital gains.

But IRS could do more to help taxpayers comply. Financial institutions already report information about investment sales to IRS and taxpayers—to make both aware of any taxable income. While some virtual currency transactions are reported, not all are. Our recommendations would improve reporting and more.