The Department of Justice issued a news release to strike terror in the hearts of anyone attempting to execute cryptocurrency tax shenanigans. The federal court for the Northern District of California entered an order authorizing a John Does summons on Payward Venture Inc and Subsidiaries d/b/a Kraken.  The IRS wants to look at the records of US taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020.

Cryptocurrency Not Sprinkled With Tax Fairy Dust

One of the fallacies that is floating around about cryptocurrencies is that they are a legitimate tool for avoiding taxation.  On a recent episode of the podcast Game of Roses, the host who goes by Bachelor Clues got into that a bit noting that if you bought a Tesla with bitcoin there would be no tax, since no dollars were exchanged.

He went on a bit from there and I thought it was worth writing a piece about that. Bachelor Clues is a thoughtful classy guy so that prompted an invitation to do a podcast with him.  By sacrificing over an hour of lifespan that you will never get back you can find out from that podcast much more about me than you probably want to know and a bit about virtual currency taxation, but there is a more efficient way to get the latter.

Straight From The IRS

You can get the key information on the topic in IRS Notice 2014-21.  Here are some of the key points

For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.

A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

The second point is the most critical.  You don’t avoid recognizing income by getting paid in virtual currency. Bitopia is not a tax haven.

The idea that virtual currency is “property” makes trying to use it as a medium of exchange a little challenging.  Every time you spend a bitcoin or dogecoin or whatever you may recognize gain or loss on the difference between what you paid for the coin and the fair market value in dollars of what you receive.  Thanks to the nature of the blockchain, which preserves every transaction forever there are services that will put it all together for you.

But Who’s Gonna Know?

You and I are both scrupulous in out tax compliance, but you might be shocked that not everybody is.  There are amoral people who will shirk their obligations, if they can get away with it.  And there are principled people who believe that taxation is theft or that paying taxes is immoral because of what governments use resources for. So is cryptocurrency a tax solution for them thanks to its presumed anonymity?

Trying to answer that question can send you down a rabbit hole.  I’ve been spending time on Reddit and Youtube sifting through material and applying my bs detector and combining that with forty years of tax experience which includes following a lot of tax litigation which gives me the benefit of other people’s experience.  The question is can you use cryptocurrencies to conceal your tax shenanigans?

I should start off by saying that you should not indulge in tax shenanigans, because it is wrong, but that ship has already sailed.  The executive summary is that it appears that there is some opportunity to hide wealth and income by using cryptocurrency, but it takes a lot more effort and expertise than most people will put into it.

Avoid Exchanges If You Want Anonymity

If you want to use exchanges to hold and trade your cryptocurrency whatever “privacy” currently exists seems like it is going to be pretty ephemeral.  There is not a comprehensive reporting infrastructure in place, but then there is the success of DOJ  in getting John Doe summonses for the IRS.  It appears that in the long run cryptocurrency exchanges will be like banks when it comes to hiding from the IRS.  In some ways they may be worse since the IRS is devoting a lot of attention to them.

So if you are looking to hide your financial misdeeds, you should be doing it yourself rather than using exchanges.  With Bitcoin, still by far the most popular virtual currency by market capitalization, although not transaction volume, you have to deal with the reality that every transaction ever is preserved in the blockchain and available for anybody to look at.

There are a lot of techniques to mitigate the blockchain transparency problem, but that is pretty much beyond the scope of this piece.  There are also cryptocurrencies that are structured differently making them more privacy oriented. Monero seems to be currently topping those lists.

For what it is worth in a piece in January on Forbes.com Hailey Lennon indicated that criminal transactions with cryptocurrencies are on the decline.  It appears that hundred dollar bills may still be the preferred vehicle for that sort of thing.

What Would Repairman Jack Do?

Almost everything I know about keeping your financial transactions, actually your very existence, hidden from the authorities, I learned from reading Repairman Jack stories by F Paul Wilson.  Jack is a sort of urban mercenary who has a very compelling reason to live off the grid.  But he is not out in the sticks. He is in Manhattan.  I discussed some of this techniques here and here.

One of the really interesting tricks was Jack’s retirement savings.  He buys Krugerrands, for cash of course, and tapes them to pipes in the wall so a metal detector cannot find them. At any rate I was wondering what Jack and his mentor, friend and gun dealer Abe would think of Bitcoin.  Fortunately their creator is pretty accessible, so I was able to ask him,

My question was what Repairman Jack and his mentor would think about Bitcoin.  F Paul Wilson replied:

Abe is the last guy to go for Bitcoin — a hard-asset man to the core. And he’s been a big influence on Jack since his 20s. So no from both.

I followed up with whether Jack would consider it as a payment method.  His answer was brief – CASH!

It may be a generational thing.  Wilson is older than me and I am 69.  Still, I would love to read a Bitcoin discussion between Abe and Jack.

Other Coverage

Bitcoin.com has Court Authorizes IRS to Summon User Records From Kraken Cryptocurrency Exchange.

Charlie Osborne has IRS secures order to serve Kraken with customer data request on cryptocurrency traders on ZD Net. The story includes a response from Kraken:

“One of Kraken’s guiding principles is maintaining the security and privacy of its client accounts. We understand that the court has expressed concern over the scope of the proposed IRS Summons. Though the posture of this case has not given Kraken an opportunity to weigh in, we share similar concerns.”

Aysha Bagchi has Kraken Crypto User Info Can Be Demanded by IRS in Tax Fight (1) behind the Bloomberg Tax paywall.

Oluwapelumi Adejmo has IRS AUTHORIZED TO SUMMON KRAKEN FOR USER INFORMATION on BITCOIN Magazine.

Jack Townsend has Court Authorizes Service of John Do Summons to Payward Ventures d/b/a Kraken, a Cryptocurrencies Service Provider (5/4/21) on Federal Tax Crimes.

Ed Zollars has IRS Granted Permission to Serve John Doe Summons for Transaction Information from Kraken Cryptocurrency Exchange on Current Federal Tax Developments.

For great value continuing professional education.  I recommend the Boston Tax Institute

You can register on-line or reach them by phone (561) 268 – 2269 or email vc@bostontaxinstitute.com.  Mention Your Tax Matters Partner if you contact them.