Although some countries do not tax crypto gains, IRS has been clear that crypto is a property for tax purposes. Americans who fail to comply may face huge criminal tax charges. To resolve the tax problems faced by crypto investors, the IRS has two programs – the Offshore Voluntary Disclosure Program and the Streamlined program. What’s more efficient between the two is worth a closer look.
In general, the world has embraced bitcoin and other cryptocurrencies. In fact, it is hard to ignore the international sensation. It is also hard to ignore the stratospheric gains, though there have been some deep price drops too. Taxes in this volatile environment can be especially worrisome.
Some countries don’t tax crypto gains, and some may not even be clear on how to classify crypto for tax purposes. But the IRS is quite clear that crypto is property (not currency) for tax purposes. Israel recently reached the same conclusion. In the case of the IRS, of course, if you are a U.S. citizen or permanent resident, you must report taxes to the IRS on a worldwide basis.
Even if you live and pay taxes abroad, you must file and pay the IRS every year. That still catches many people by surprise. Indeed, some Americans are still coming forward under tax amnesty plans started in 2009 when UBS and other Swiss banks were facing fines and threats of prosecution from U.S. authorities. In a way, that is where a curious crossover seems to be happening.
There has long been speculation that a special IRS amnesty program will be announced for bitcoin and other digital currency taxpayers. It would sure be nice. The number of crypto investors who are vocally worrying on whether and how to get into compliance with the IRS suggests that the IRS should try to welcome them home. There’s a good deal of tax cleanup that some people need to do.
Everyone knows that tax compliance with crypto has been poor. In a widely quoted report, the IRS has said that in 2014, only 802 taxpayers reported crypto gains. The compliance may have gotten better since then, but out of millions of impacted taxpayers, 802 is an astoundingly low figure, even for 2014. That is one reason why the IRS has trained its criminal IRS agents to pursue this.
It is also why the IRS is using tracking software to hunt crypto accounts, and why it successfully went after Coinbase accounts via summons. In the case of cryptocurrencies, amnesty seems overdue. Even government officials have mentioned the idea of an IRS tax amnesty. But for now, the IRS has not announced one. In the meantime, we still must file tax returns every year.
For crypto investors who need to rectify their past tax transgressions, there is no formal IRS program to control the risks and to guarantee a particular or formulaic tax result. A predictable tax and penalty result is what IRS amnesty programs usually provide. It was one reason why the IRS offshore account amnesty programs were such a resounding success. Over 50,000 taxpayers have participated, and the IRS has collected over $10 billion.
A guaranteed safe process and a predictable dollar result were clearly key to that astounding success. You can address bitcoin (or offshore accounts) without a formal amnesty, of course, but man taxpayers are reluctant. Even without a formal amnesty, amending a few returns to pick up additional income you failed to report is usually pretty safe.
Among other factors, timing is key. If the IRS finds you first through an audit, you will clearly not be protected. In some cases, even criminal prosecution is possible. Corrections that look sneaky or less than transparent can also raise worries. Sometimes it is the taxpayer’s own behaviour in an audit that triggers the biggest criminal risk.
Indeed, most criminal tax cases arise from regular civil IRS tax audits. Timing and overall handling of an audit can be terribly important. What if you aren’t comfortable just preparing and filing a few tax returns, or a few or amended tax returns to correct your mistakes?
For more serious transgressions, traditionally, if you voluntarily go to the IRS through a lawyer to correct your tax problems before the IRS discovers them, you won’t be prosecuted. Admitting your mistakes isn’t easy, and one can feel pretty vulnerable with a powerful agency like the IRS. So, is there any way to guarantee a more predictable tax result now, even before the IRS announces a formal crypto amnesty?
Although there is not yet a no special IRS amnesty for crypto, there’s still one for offshore accounts. If you have an offshore account, the IRS amnesty can offer crypto investors a kind of back door. With extensive data swapping deals between the IRS, foreign governments, and foreign banks, almost no offshore account is secret anymore.
Even so, the IRS amnesty is still on the table. Offshore account holders can still safely fix their problems, even if they intentionally evaded reporting in the past. The cost of the IRS amnesty can be small compared to the risk of vastly larger civil penalties, and the threat of criminal prosecution. For offshore bank accounts, civil FBAR penalties alone can entirely wipe out foreign accounts.
There are two IRS programs, the OVDP, or Offshore Voluntary Disclosure Program, and the Streamlined program. The OVDP is a clean wash-your-hands kind of way to correct past tax filings and come clean. It involves filing up to eight years of tax returns (or amended tax returns) and FBARs.
You pay taxes, interest and a 20 percent penalty on whatever you owe. For most people, there’s also a 27.5 percent penalty on your highest offshore account balance. In some cases, that penalty can be 50 percent, depending on the bank and timing.
In contrast, the Streamlined program involves only three years of tax returns. You file six FBARs in Streamlined instead of three, to match the longer FBAR statute of limitations. The Foreign Streamlined program (for U.S. persons abroad) has no penalty. The Domestic Streamlined program involves a 5 percent penalty pegged to the highest offshore account balance over the six FBAR years.
Still, the Streamlined program requires a non-willfulness statement that can be risky in some cases. And Streamlined filings are subject to IRS audit. These audits can be brutal, so in choosing OVDP or streamlined, you should consider IRS audits. Thus, for crypto investors with risk, the OVDP seems a far better hook for resolving crypto tax problems.
As long as you are filing amended tax returns, other corrections unrelated to your foreign accounts can be handled too. After all, before you sign amended tax returns under penalties of perjury, you should make sure they are accurate. If you failed to report any other income, you should include it on your amended returns.
By its terms, the OVDP applies to foreign account matters. Other corrections are technically not part of the OVDP, so the IRS could pursue these items outside the OVDP. In reality, though, the IRS appears to be processeding them all together. In short, if you have other unrelated corrections to your returns, by all means make them.
In fact, cleaning up domestic tax problems is a feature of many OVDP cases. As the IRS puts it, domestic parts of a voluntary disclosure are subject to IRS examination. See IRS FAQ 7.1. Taxpayers can use the OVDP, but note on the Offshore Voluntary Disclosure Letter that they are also making a domestic voluntary disclosure. See IRS FAQ 24. The IRS appears to be accustomed to the usual full disclosure including domestic tax problems too.
To be sure, the domestic tax issues might be large, particularly given the dramatic run-up of crypto investments. However, the OVDP should still allow the IRS to collect taxes, interest, plus a 20 percent penalty on any unreported income. Remember, a key IRS tradition is that even terribly noncompliant taxpayers who voluntarily step forward before they are found are usually not prosecuted.
Plainly, OVDP tax return packages can fix domestic tax problems unrelated to foreign accounts. Usually, all seems to go fine, and there may be no real alternative. Given the costs, most taxpayers have an easier time deciding to file Streamlined rather than the more expensive OVDP.
Notably, though, the OVDP precludes criminal prosecution and ends in a closing agreement. In contrast, Streamlined filers can face a civil audit or conceivably even prosecution. A key for any Streamlined filer is to be non-willful and to certify that.
Negligence, inadvertence, or mistake are all OK, but intent to conceal or to evade taxes is not. And the IRS has criteria for objective indicators. It is hard to say you were non-willful if you behaved secretively, did partial reporting of accounts or income, etc.
The bottom line is that crypto investors with tax problems might consider the OVDP. The facts and the details really matter, so getting competent professional tax advice is important. But, until the IRS has a special crypto amnesty, resolving such problems through the OVDP might be worth a look.
About the Author
Robert W. Wood is a tax lawyer representing clients worldwide from offices at Wood LLP, in San Francisco (www.WoodLLP.com). He is the author of numerous tax books, and writes frequently about taxes for Forbes.com, Tax Notes, and other publications. This discussion is not intended as legal advice.