As tax season approaches, cryptocurrency investors and their advisors are facing heightened scrutiny. The New York State Office of the Attorney General recently announced its commitment to hold “cryptocurrency tax cheats accountable.” Taxpayers who fail to properly declare their crypto income could face treble damages, interest, and penalties under the New York False Claims Act, in addition to criminal prosecution and separate liabilities and penalties under the tax law.
A key takeaway from New York’s development is that liability is not limited to those who fail to pay their taxes. Under the New York False Claims Act, accountants, lawyers, and other tax professionals who knowingly or recklessly cause taxpayers to under-report the tax they owe from cryptocurrency transactions may also face enforcement action.
This state-level shift to threaten enforcement against gatekeepers mirrors similar rumblings from the SEC. In November, Director Grewal warned that the SEC would take a hard look at attorneys and accountants who advise their clients to walk right up to the line in the cryptocurrency space.
The federal government and several other states have increased their focus on the regulation and taxation of cryptocurrency and other digital assets. On March 9, 2022, President Biden issued an executive order calling for evolution and alignment of the federal government’s approach to digital assets with key priorities to include: consumer and investor protection; financial stability; illicit finance; U.S. leadership in the global financial system and economic competitiveness; financial inclusion; and responsible innovation. This call to action reflects the government’s desire to take more focused and coordinated steps to address the risks and cultivate the benefits of digital assets and their related technology.
From a federal tax perspective, the IRS began its focus on the taxation of “virtual” currency nearly a decade ago. Over the years, the IRS disseminated guidance in this area including IRS Notice 2014-21, IRB 2014-16 (and related FAQs), Rev. Rul. 2019-24, IRS Chief Counsel Memorandum 202114040, and others. These authorities generally provide that virtual currencies are treated as property (not fiat currency) for federal income tax purposes, and they describe how existing tax principals apply to various virtual currency transactions.
Furthermore, the IRS Priority Guidance Plan for 2021-2022, which outlines the IRS’s priorities for allocating resources to matters most important to taxpayers and tax administration, includes as its focus: (i) general guidance concerning virtual currency; and (ii) regulations regarding information reporting on virtual currency under Sec. 6045 of the Internal Revenue Code.
Both New York and New Jersey have joined a handful of states in addressing the tax treatment of virtual currencies from an income, sale/exchange and sales tax perspective. California Attorney General Rob Bonta recently acknowledged that crypto is an “area of concern.” The current tone of the rhetoric from our legislative and executive branches suggests that tax authorities will continue to focus more on providing detailed rules applicable to taxation, reporting, and compliance with respect to digital assets.
It remains to be seen whether the tough talk from state and federal enforcers leads to an uptick in prosecutions, but it would behoove crypto traders and their professional advisors to make sure all their i’s are dotted and t’s are crossed this tax season.
If you have questions regarding the application of recent guidance, regulations or laws, please reach out to one of the authors.