IRS Must Update Virtual Currency Guidance and Forms, TIGTA Says

IMPACT ON TAXPAYERS

Alternative payment methods, such as convertible virtual currencies, have grown in popularity in recent years and have emerged for some people as a potential alternative to using traditional currencies like U.S. dollars. Virtual currencies offer potential benefits over traditional currencies, including lower transaction fees and faster transfer of funds for services provided. However, some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions.

WHY TIGTA DID THE AUDIT

Recently, many types of virtual currencies have been created for use in lieu of currency issued by a government to purchase goods and services in the real economy. The overall objective of this review was to evaluate the IRS's strategy for addressing income produced through virtual currencies.

WHAT TIGTA FOUND

Although the IRS issued Notice 2014-21, Virtual Currency Guidance, and established the Virtual Currency Issue Team, there has been little evidence of coordination between the responsible functions to identify and address, on a program level, potential taxpayer noncompliance issues for transactions involving virtual currencies. None of the IRS operating divisions have developed any type of compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currencies. In addition, it does not appear that any of the actions already taken by the IRS to address virtual currency tax noncompliance were coordinated to ensure that the IRS maintains a strategic approach to the tax implications of virtual currencies.

Although the IRS requested comments to Notice 2014-21 from the public, no actions were taken to address the comments received. TIGTA reviewed all the comments and found several examples of information requested by the public that would be helpful in understanding how to comply with the tax reporting requirements when using or receiving virtual currencies.

In addition, third-party methods of reporting taxable transactions to the IRS do not separately identify transactions related to virtual currencies. While employers and businesses are required to report taxable virtual currency transactions, current third-party information reporting documents do not provide the IRS with any means to identify that the taxable transaction amounts being reported were specifically related to virtual currencies.

WHAT TIGTA RECOMMENDED

TIGTA recommended that the IRS: 1) develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation; 2) provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies; and 3) revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.

The IRS agreed with TIGTA's recommendations and plans to develop a virtual currency strategy including an assessment of whether changes to information reporting documents are warranted. The IRS also agreed that additional guidance would be helpful and plans to share the recommendation with the IRS's Office of Chief Counsel for coordination with the Department of the Treasury's Office of Tax Policy.

Management's complete response to the draft report is included as Appendix V.

Copies of this report are also being sent to the IRS managers affected by the report recommendations. If you have any questions, please contact me or Matthew A. Weir, Assistant Inspector General for Audit (Compliance and Enforcement Operations).

                           Table of Contents

Virtual currencies offer potential benefits over traditional currencies, including lower transaction fees and faster transfer of funds for services provided. However, some virtual currencies are also popular because the identity of the parties involved is generally anonymous, leading to a greater possibility of their use in illegal transactions.

According to the Government Accountability Office (GAO), a virtual currency is generally considered a digital unit of exchange that is not backed by a government-issued legal tender. Virtual currencies originally were used in the online gaming industry. Recently, many types of virtual currencies have been created for use in lieu of a government-issued currency to purchase goods and services in the real economy.² Although there are approximately 250 active virtual currencies listed, bitcoin is by far the most popular, comprising nearly 82 percent of the entire virtual currency market.³ Between May 2013 and April 2016, the number of bitcoins in circulation increased from approximately 11.2 million to more than 15.4 million, while the number of daily transactions related to bitcoins has grown from 58,795 to about 220,804.⁴ As of April 21, 2016, one bitcoin had the price equivalent of approximately $443, and bitcoins had a total market value of more than $6.8 billion.⁵

Bitcoin was introduced in Calendar Year 2009 by an unidentified programmer or programmers using the name Satoshi Nakamoto. The bitcoin computer protocol permits the storage of unique digital representations of value (bitcoins) and facilitates the assignment of bitcoins from one user to another through an Internet-based peer-to-peer network. Bitcoins are divisible to eight decimal places, thereby enabling their use in any kind of transaction regardless of their value.

Bitcoins are created and entered into circulation through a process called mining. Bitcoin miners download free software that they use to solve complex mathematical equations. This process verifies the validity of the bitcoin transactions by grouping several transactions into a block and mathematically proving that the transactions occurred and did not involve double spending of a bitcoin. When a miner or group of miners (mining pools) solves an equation, the bitcoin network accepts the block of transactions as valid and creates new bitcoins and awards them to the successful miner or mining pool. In addition to mining, bitcoins already in circulation can be acquired by accepting them as gifts or payments for goods or services, purchasing them at bitcoin kiosks (sometimes referred to as bitcoin automated teller machines), or purchasing them on third-party exchanges.⁶

To describe how existing general tax principles apply to transactions using virtual currency, the Internal Revenue Service (IRS) issued Notice 2014-21, Virtual Currency Guidance, in March 2014. The notice provides that virtual currencies should be treated as property for tax purposes. Notice 2014-21 also provides answers to 16 frequently asked questions (FAQ) on virtual currencies. The FAQs provide basic information on the U.S. Federal tax implications of transactions in, or transactions that use, virtual currencies. The same general tax principles that apply to property transactions apply to transactions using virtual currencies. Among other things, this means that:

• The fair market value of virtual currency paid as wages is subject to Federal income tax withholding, Federal Insurance Contributions Act tax, and Federal Unemployment Tax Act tax and must be reported on Form W-2, Wage and Tax Statement.

• Payments using a virtual currency made to independent contractors are taxable, and self-employment tax rules apply. Generally, payers must issue a Form 1099-MISC, Miscellaneous Income, to the IRS and to the payee.

• The character of gain or loss from the sale or exchange of a virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

• A payment made using a virtual currency is subject to information reporting to the same extent as any other payment made in property.

According to IRS management, the Large Business and International Division's Offshore Arrangements Practice Network Steering Committee established the Virtual Currency Issue Team (VCIT) in December 2013 to get a better understanding of how virtual currencies may affect international taxable transactions. Specifically, the original focus of the VCIT was the identification of international underreporting strategies using virtual currency to facilitate tax avoidance/evasion schemes. In April 2015, the VCIT's focus was expanded to act as a forum for interested individuals from various IRS offices and functions to meet and share knowledge on virtual currency. The VCIT includes members from the IRS's Office of Chief Counsel and Criminal Investigation as well as the Large Business and International Division and the Small Business/Self-Employed Division. The VCIT's current efforts are to: 1) determine if virtual currencies are being used as a method to hide income and avoid U.S. taxation; 2) be a vehicle to share virtual currency knowledge across the IRS; and 3) identify audit techniques that can be used to determine if taxpayers using virtual currencies in transactions, especially in offshore arrangements, are attempting to conceal income and avoid U.S. taxation.

The VCIT has met periodically to learn about virtual currencies and share knowledge. According to IRS management, in Fiscal Year 2015, the VCIT developed virtual currency training that was presented to more than 200 Large Business and International Division employees in two online sessions and is available online for tax compliance employees in other divisions to review. The training mostly focused on understanding the basics of virtual currency, including the mining of virtual currency, as well as the uses of virtual currency and associated terminology. The training also identified some of the audit techniques and tools examiners could use to identify virtual currency transactions.

Additionally, members of Criminal Investigation's Financial Crimes function provided virtual currency awareness presentations in Fiscal Years 2015 and 2016 to more than 300 special agents. According to Criminal Investigation management, the purpose of these presentations was to provide "a general overview of what virtual currency is and in particular what bitcoin is and how it works."

This review was performed at the Large Business and International Division Headquarters in Washington, D.C., with information obtained from Criminal Investigation, the Large Business and International and Small Business/Self-Employed Divisions, and the Office of Chief Counsel during the period of October 2015 through June 2016. We conducted this performance audit 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 objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.

IRS management needs to develop an overall strategy to address taxpayer use of virtual currencies as property and as currency. In Calendar Year 2013, the GAO reported:

Virtual currency and the Bank Secrecy Act

The Bank Secrecy Act (BSA), which was enacted to help prevent money laundering, creates a number of reporting obligations upon financial institutions and money services businesses (MSB).⁸ MSBs include check cashers, issuers and redeemers of travelers' checks and money orders, and money transmitters.⁹ MSBs are subject to the BSA reporting requirements, including Currency Transaction Reports and Suspicious Activity Reports.¹⁰

Under delegated authority from the Department of the Treasury's Financial Crimes Enforcement Network (FinCEN), the IRS has BSA enforcement responsibilities for financial institutions not regulated by a Federal bank agency or another Federal regulator. The IRS pursues BSA enforcement responsibilities through its Specialty Examination function in the Small Business/Self-Employed Division and pursues criminal violations of the BSA through its Criminal Investigation.

In March 2013, the FinCEN issued interpretive guidance that addresses the applicability of the BSA to persons creating, obtaining, distributing, exchanging, accepting, or transmitting virtual currency. The guidance provides information to help taxpayers determine whether their activities with virtual currencies classify them as an MSB, which are types of nonbank financial institutions that are regulated by the BSA.¹¹ Specifically, these guidelines distinguish the differences between users, administrators, and exchanges of virtual currency. For example:

• A user is a person who obtains virtual currency to purchase goods or services.

• An administrator is a person who is engaged as a business in using (putting into circulation) a virtual currency and who has the authority to redeem (to withdraw from circulation) such virtual currency.

• An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.

As an MSB, virtual currency administrators and exchanges are required to comply with the Department of the Treasury's reporting requirements, including Suspicious Activity Reports.¹³ The failure to follow these rules would subject virtual currency administrators and exchanges to significant civil and criminal liability.¹⁴

In January 2014, the FinCEN issued clarifying rulings on virtual currency miners and investors. The first ruling states that to the extent a user creates or "mines" a virtual currency solely for a user's own purposes, the user is not a money transmitter under the BSA. The second ruling states that a company purchasing and selling virtual currency as an investment exclusively for the company's benefit is not a money transmitter.

By virtue of the FinCEN rulings, the IRS has significant tools available to help ensure that virtual currency exchanges are following the law and that unscrupulous individuals are not engaged in criminal activities through the use of virtual currencies. However, the IRS has primarily focused its limited virtual currency efforts on tax compliance issues and not enforcement of the potential criminal activities that are subject to the BSA. Although FinCEN guidance deems that virtual exchanges are MSBs subject to BSA regulation, the IRS did not include representatives from the Small Business/Self-Employed Division's BSA Program on the VCIT. Additionally, Small Business/Self-Employed Division Examination Policy function management was unaware of any strategies under development for BSA compliance enforcement related to virtual currency administrators or exchanges.

Enforcement efforts to date

In an October 2014 news article related to virtual currency, Bloomberg Bureau of National Affairs quoted Criminal Investigation management as saying that "agents will be targeting the use of the [virtual] currency to dodge taxes."¹⁵ When we followed up with Criminal Investigation management to determine what steps have since been taken to identify taxpayers that are using virtual currency to "dodge taxes," we were told that nothing specific has been done.

Criminal Investigation management stated that most of the criminal cases involving virtual currency are related to narcotics and money laundering and provided us general information on five closed criminal investigation cases that involved virtual currency. In most of these case examples, the criminal allegation was for operating a bitcoin exchange without an MSB license or FinCEN registration in violation of 18 United States Code (U.S.C.) Section 1960.¹⁶ While the number of cases to date is small, it is significant that Criminal Investigation was able to disrupt potential criminal enterprises using laws, such as the BSA, governing MSBs.

There was one significant case example cited to us that involved Ross Ulbricht, the creator and operator of the "Silk Road" website. Criminal Investigation participated in an investigation along with several other Federal Government agencies. According to court documents, Ulbricht created the Silk Road in January 2011 and owned and operated the underground website until it was shut down by law enforcement authorities in October 2013. The Silk Road served as a sophisticated and extensive criminal marketplace on the Internet where unlawful goods and services, including illegal drugs of virtually all varieties, were bought and sold regularly by the site's users. While in operation, the Silk Road was used by thousands of drug dealers and other unlawful vendors to distribute hundreds of kilograms of illegal drugs and other unlawful goods and services to more than 100,000 buyers, and to launder hundreds of millions of dollars deriving from these unlawful transactions. Ulbricht sought to anonymize transactions on the Silk Road by operating it on a special network of computers on the Internet designed to conceal the identities of the networks' users. Ulbricht also designed the Silk Road to include a bitcoin-based payment system that concealed the identities and locations of the users transmitting and receiving funds through the site.

The Silk Road case is an example of a successful collaborative Federal investigation, but it is also a reminder that the anonymity feature of some virtual currencies is what attracts unscrupulous individuals to their use. The IRS should prepare a comprehensive virtual currency strategy that will assist taxpayers lawfully engaged with virtual currencies to voluntarily comply with the tax laws while seeking to identify individuals unlawfully engaged in their use.

Although the IRS established the VCIT and issued Notice 2014-21, there has been little evidence of coordination between the responsible functions to identify and address, on a program level, potential taxpayer noncompliance issues for transactions involving virtual currencies. None of the IRS operating divisions have developed any type of compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currency. In addition, it does not appear that any of the actions already taken by the IRS to address virtual currency tax noncompliance were coordinated to ensure that the IRS develops the overall "big picture" associated with taxpayer use of virtual currencies. However, according to Large Business and International Division management, in January 2016, a subgroup of the VCIT was established to look at the feasibility of creating a campaign around how the IRS should address tax noncompliance related to virtual currency. This work is still in the discussion stages.

To encourage and support results-oriented management, the Government Performance and Results Act was enacted by Congress to require Federal agencies to develop strategic plans, set performance goals, and report annually on their performance results as compared to their established goals.¹⁷ With the implementation of this legislation, the IRS is required to integrate these plans and goals into its operational management regime.

The IRS needs to ensure that it develops a strategic plan that includes management oversight as well as adequate internal controls for its virtual currency programs. Until a comprehensive virtual currency strategy is developed, the IRS is open to the risk that undetected noncompliance of virtual currency taxable transactions will result in an increase to the Tax Gap.

Recommendation

Recommendation 1: The Deputy Commissioner for Services and Enforcement should request the Large Business and International Division, the Small Business/Self-Employed Division, and Criminal Investigation to develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation. In addition, the strategy should use the tools available to the IRS and identify how the IRS is going to meet its BSA, criminal investigation, and tax enforcement obligations as related to virtual currencies as well as identify how actions will be monitored and the methodologies used to measure the actions taken.

Notice 2014-21 states, "the IRS is aware that 'virtual currency' may be used to pay for goods and services or held for investment." Although the IRS officially stipulates that virtual currency should be treated as property, taxpayers can still use it as currency in small transactions, such as purchasing a cup of coffee or a digital song download, or in large transactions, such as renting an apartment or purchasing a vehicle or a home. Additionally, Notice 2014-21 describes:

Notice 2014-21 requires a taxpayer who receives virtual currency as payment for goods or services to compute gross income using the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency is received. However, because bitcoins are divisible to eight decimal places, this means that each bitcoin can be divided up into 100 million pieces. Based on this general guidance, when a portion of a bitcoin is used to make a purchase, taxpayers will have to treat the transaction as property and determine their tax basis for the bitcoin on the day of the purchase. For example, if a taxpayer uses a portion of a bitcoin to buy a cup of coffee each day for one week, he or she will have to determine what portion of the bitcoin was used to make the purchase based on the daily exchange rate, convert it into U.S. dollars, and keep a record of each transaction so that the gain or loss from his or her virtual currency property can be properly reported. Notice 2014-21 does not provide taxpayers with guidance on what records should be kept and how the records should be maintained. Due to the potential complexity of reporting otherwise simple retail purchase transactions related to virtual currencies, further guidance is needed to help taxpayers voluntarily comply with their tax obligations.

In addition, U.S. employees who are paid bitcoins as wages for services provided to their employers face similar challenges.¹⁸ Although employers need to accurately calculate the Social Security taxes and other withholdings for their employees in U.S. dollars, employees who receive bitcoins as wages need to maintain accurate records, especially if they do not immediately use or convert their bitcoins received as wages into currency. Once bitcoins are used or converted, there may be a gain or loss that needs to be recorded so that the gain or loss can be accurately reported on the employee's tax return. Further guidance regarding recordkeeping may provide valuable assistance to employees who may not be accustomed to getting paid in property. This is especially true for those employees who consider the bitcoin amounts received as "wages" because their employer reports to the IRS the wages the employee received in bitcoins as U.S. dollars on the employee's Form W-2.

In addition to receiving virtual currency as a payment for goods and services, some members of the public receive virtual currency as payment for services associated with mining virtual currencies. Notice 2014-21 requires that when a taxpayer successfully "mines" virtual currency, the fair market value of the currency as of the date of receipt is includible in gross income. However, properly reporting the correct amount could become complex because of fluctuations in bitcoin valuation and because some miners may only be receiving portions of a bitcoin instead of a whole bitcoin.

In March 2014, the IRS requested comments to Notice 2014-21 from the public about the virtual currency information explained in the notice. To date, the IRS has received and reviewed 36 comments submitted by the public; however, no actions were taken to address the comments received. We reviewed all the comments and found several examples of information requested by the public that would be helpful in understanding how to comply with the tax reporting requirements when using or receiving virtual currencies.

The public identified three primary issues, which included comments on the burden of:

• Keeping track of transactions associated with virtual currencies when they are used as property. The public requested information about the valuation method to be use for virtual currencies and the lack of an official valuation source. The public also expressed concerns about the impact on businesses that would have to keep track of gains or losses on all transactions because virtual currencies are to be treated as property instead of currency. Some of the comments point out that the recordkeeping of each transaction will be become onerous for people who use virtual currencies in everyday purchases.

• Keeping track of the cost and payments related to mining bitcoins. The public requested information about how to account for bitcoins earned in the mining process because some people only own the equipment used for mining. Some comments explained that some taxpayers pool their computer resources together to help solve the bitcoin equations so only partial pieces are earned at different times, and the coins earned can be received multiple times in the same day.

• Determining how to ensure tax compliance of transactions involving virtual currencies. The public requested information about whether virtual currencies could be used in individual retirement or investment accounts or given as charitable contributions. The public wanted to know what accounting method to use to report sales transactions involving virtual currencies.

Unlike the IRS, the Australian Taxation Office addressed the need for tax guidance in differentiating between the various uses of virtual currencies. For example, both the Australian Taxation Office and the IRS determined that virtual currencies, like bitcoin, are assets for capital gains tax purposes. However, when using them to pay for personal transactions, the Australian Taxation Office decided that there will be no income tax implications if the person is not in business or carrying on an enterprise and is simply paying for goods or services. Any capital gain or loss realized from the disposal of the virtual currency is to be disregarded provided its cost is $10,000 (Australian dollars) or less.

During discussions with IRS management, our auditors were told that no changes to the IRS guidance would be made based on the comments received from the public. With questions that the public has about recordkeeping, mining, and tax compliance reporting for virtual currencies, some potential for noncompliance exists because the detailed guidance needed by taxpayers to properly comply with their virtual currency tax obligations was not provided by the IRS.

Recommendation

Recommendation 2: The Deputy Commissioner for Services and Enforcement should take action to provide updated guidance to reflect the documentation requirements and tax treatments needed for the various uses of virtual currencies.

Current third-party methods of reporting taxable transactions to the IRS, such as Form W-2, Form 1099-MISC, and Form 1099-K, Payment Card and Third Party Network Transactions, do not separately identify transactions related to virtual currency. For example, in the FAQs for Notice 2014-21, it states, "the fair market value of virtual currency paid as wages is subject to Federal income tax withholding, Federal Insurance Contributions Act tax, and Federal Unemployment Tax Act tax and must be reported on Form W-2 . . ." Notice 2014-21 also refers employers to Publication 15, which addresses the filing of Form 1099-MISC to report payments of $600 or more to persons not treated as employees (independent contractors) for services performed for a trade or business. In the FAQs, it states that:

The GAO's Standards for Internal Control in the Federal Government provides five components for internal control.²¹ These include:

• Control Environment.

• Risk Assessment.

• Control Activities.

• Information and Communication.

• Monitoring.

In April 2016, the IRS estimated that the average gross Tax Gap for Tax Years 2008 through 2010 was $458 billion per year. The largest portion of the Tax Gap, $387 billion annually, is due to underreporting. According to the IRS, taxpayer compliance is higher when income is subject to third-party information reporting and even higher when also subject to withholding. IRS Tax Gap analyses found that, "Misreporting of income amounts subject to substantial information reporting and withholding is 1 percent; of income amounts subject to substantial information reporting but not withholding, it is 7 percent; and of income amounts subject to little or no information reporting, such as nonfarm proprietor income, it is 63 percent." In addition, the latest Taxpayer Attitude Survey from the IRS Oversight Board, issued in December 2014, found that personal integrity and third-party reporting are the top two factors having a "great deal of influence" on whether taxes are reported and paid honestly.

The IRS already uses third-party reporting documents to verify information claimed by taxpayers on their tax returns. The IRS's Automated Underreporter (AUR) program systemically compares amounts shown on a taxpayer's tax return with information reported on third-party documents such as Form 1099-B, Proceeds From Broker and Barter Exchange Transactions. For example, the AUR program matches the proceeds reported by a barter exchange with the income claimed by a taxpayer on his or her tax return.²² IRS guidelines identify bartering as an exchange of one taxpayer's property or services for another taxpayer's property or services without the use of currency. The fair market value of property or services received through barter is taxable income. The barter exchanges are required to report their members' transactions to the IRS on Form 1099-B.

Form 1099-B contains a box showing the proceeds from bartering, which allows the IRS to specifically identify bartering transactions. The AUR program uses this information to identify when bartering proceeds reported by a third party do not agree with what was reported by a taxpayer. The IRS may correspond with the taxpayer for additional information if it appears that bartering income was underreported. These contacts with the taxpayer can result in adjustments to the tax return.

Form 1099-B has been revised since its introduction in Tax Year 1983 to provide the IRS with information regarding additional taxable transactions. Figure 1 is an example of the Tax Year 1983 Form 1099-B before any revisions.

 

Figure 1: Copy of Tax Year 1983 Form 1099-B

 

 

 

 

Figure 2: Copy of Tax Year 2016 Form 1099-B

 

 

 

Recommendation

Recommendation 3: The Deputy Commissioner for Services and Enforcement should revise third-party information reporting documents to identify the amounts of virtual currency used in taxable transactions.

² GAO, GAO-13-516, Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks (May 15, 2013).

³Map of Coins (Mapofcoins.com).

⁴CoinDesk (Coindesk.com).

⁵CoinMarketCap (Coinmarketcap.com). This is the price that an asset would fetch in the marketplace. Market value is also commonly used to refer to the market capitalization of a publicly traded company and is obtained by multiplying the number of its outstanding shares by the current share price.

⁶ These third-party exchanges allow users to exchange traditional currencies, such as U.S. dollars, for bitcoins and exchange bitcoins back to traditional currencies.

⁷ GAO, GAO-13-516, Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks (May 15, 2013).

⁸ Pub. L. No. 91-508, 84 Stat. 1114-4 (1970) (codified as amended in scattered sections of 12 United States Code (U.S.C.), 18 U.S.C., and 31 U.S.C.). Regulations for the Bank Secrecy Act and other related statutes are 31 Code of Federal Regulations (CFR) Sections (§§) 103.11-103.77.

⁹ 31 CFR § 1010.100(ff) (2011).

¹⁰ 31 CFR § 1022.311 (2015) as to Currency Transaction Reports and 31 CFR § 1022.320 (2011) as to Suspicious Activity Reports.

¹¹ The IRS's website (IRS.gov) identifies the following types of businesses as examples of MSBs: money transmitters; currency dealers or exchanges; and check cashers or issuers of traveler's checks, money orders, or stored value cards. There are other requirements to being considered an MSB, including engaging in one or more transactions on or after September 20, 1999, in an amount greater than $1,000, in currency or monetary instruments, for any person and during any one day.

¹² FinCEN regulations provide that whether a person is a money transmitter is a matter of facts and circumstances. The regulations identify the circumstances under which a person is not a money transmitter despite accepting and transmitting currency, funds, or value that substitutes for currency. See 31 CFR § 1010.100(ff)(5)(ii)(A)-(F).

¹³ 31 CFR § 1022.320 describes the suspicious reporting obligation as follows:

¹⁵ Allison Bennett, Virtual Currency: FinCEN Virtual Currency Rulings May Make Tax Audits, Enforcement Easier, Analyst Says, BNA Daily Tax Report (Oct. 30, 2014).

¹⁶ Pursuant to 31 U.S.C. § 5330, all MSBs must register with the FinCEN.

¹⁷ Pub. L. No. 103-62, 107 Stat. 285 (codified as amended in scattered sections of 5 U.S.C., 31 U.S.C., and 39 U.S.C.).

¹⁸ According to various organizational websites and news articles, employees who work for organizations and businesses like The Bitcoin Foundation, Coinbase, and The Internet Archive have the option of their salaries being paid in bitcoins.

¹⁹ GAO, GAO-11-750, Financial Derivatives: Disparate Tax Treatment and Information Gaps Create Uncertainty and Potential Abuse (October 2011).

²⁰ In general, a third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third-party settlement organization as defined in Notice 2014-21.

²¹ GAO, GAO-14-704G, Standards for Internal Control in the Federal Government (Sept. 2014).

²² Internal Revenue Code § 6045(c)(3) defines a barter exchange as any organization of members providing property or services who contract to trade or barter the property or services.

I. Evaluated the IRS's compliance strategy for addressing the use of virtual currencies for taxable transactions.

Internal controls relate to management's plans, methods, and procedures used to meet their mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. We determined that the following internal controls were relevant to our audit objective: IRS policies, procedures, guidance, and training pertaining to virtual currency. To evaluate these controls, we interviewed management in the Large Business and International Division, the Small Business/Self-Employed Division, Criminal Investigation, and the Office of Chief Counsel. We obtained and analyzed relevant policies, procedures, and guidance, and reports provided in regard to training, guidance to the public, and VCIT meeting minutes.

Bryce Kisler, Director

Alan Lund, Audit Manager

Javier Fernandez, Acting Audit Manager

Michele Jahn, Acting Audit Manager

Gwendolyn Green, Lead Auditor

David Hartman, Senior Auditor

Office of the Commissioner -- Attn: Chief of Staff

Chief Counsel

Chief, Criminal Investigation

Commissioner, Large Business and International Division

Commissioner, Small Business/Self-Employed Division

Commissioner, Wage and Investment Division

Director, Office of Audit Coordination

The open source software used to create the bitcoin virtual currency and the peer-to-peer network formed as a result (when capitalized). The individual units of the bitcoin virtual currency (when lowercase).

Convertible Virtual Currency

Virtual currency that has an equivalent value in real currency or that acts as a substitute for real currency.

Fair Market Value

A selling price for an item or property at which a buyer and seller will agree to do business.

Fiscal Year

Any yearly accounting period, regardless of its relationship to a calendar year. The Federal Government's fiscal year begins on October 1 and ends on September 30.

Information Reporting Document

A return that includes any form, statement, or schedule required to be filed with the IRS with respect to any amount from which tax is required to be deducted and withheld.

Internal Revenue Code

Federal tax law begins with the Internal Revenue Code, enacted by Congress in Title 26 of the U.S.C. It is the main body of domestic statutory tax law of the United States organized topically, including laws covering the income tax, payroll taxes, gift taxes, estate taxes, and statutory excise taxes. Its implementing agency is the IRS.

Money Services Business

A type of nonbank financial institution. They include the following types of businesses: money transmitters, currency dealers or exchanges, and check cashers or issuers of traveler's checks, money orders, or stored value cards.

Tax Gap

The estimated difference between the amount of tax that taxpayers should pay and the amount that is paid voluntarily and on time.

Tax Year

A 12-month accounting period for keeping records on income and expenses used as the basis for calculating the annual taxes due. For most individual taxpayers, the tax year is synonymous with the calendar year.

Virtual Currency

A digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.

As outlined in the report, we have completed some preliminary compliance work related to virtual currencies, including several criminal investigations that have successfully disrupted criminal enterprises that were using virtual currencies in their illegal transactions. We have also issued guidance to taxpayers on virtual currencies, in addition to developing and delivering training to our employees on this emerging issue. But we agree that more can be done to develop a coordinated virtual currency strategy, and we will work on further developing the IRS' overall strategic approach to virtual currencies, taking into account the findings in your report. Indeed, a cornerstone of the LB&I Future State is to improve our flexibility to respond to emerging issues such as these, for example, via the development of strategic and coordinated campaigns that would deploy tailored treatments streams for addressing tax compliance -- using both enforcement tools (such as examinations and criminal investigations for addressing noncompliance or illegal transactions), as well as outreach, education and training on compliance with the tax obligations surrounding virtual currencies.

The corrective actions that the IRS will take to address the recommendations are more fully described in the attachment. If you have any questions, please contact me, or a member of your staff may contact Pamela Drenthe, Director, Withholding & International Individual Compliance, at (202) 515-4417.

Attachment

RECOMMENDATION 1:

The Deputy Commissioner for Services and Enforcement should request the Large Business and International Division, the Small Business/Self-Employed Division, and Criminal Investigation to develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation. In addition, the strategy should use the tools available to the IRS and identify how the IRS is going to meet its Bank Secrecy Act (BSA), criminal investigation, and tax enforcement obligations as related to virtual currencies as well as identify how actions will be monitored and the methodologies used to measure the actions taken.

CORRECTIVE ACTIONS:

IRS agrees that a comprehensive virtual currency strategy is important. LB&I will collaborate with other business operating divisions to identify potential noncompliance in this area, and develop the appropriate strategy for addressing such noncompliance. Criminal Investigation will coordinate with the divisions to promote fraud awareness relative to virtual currency compliance issues and assist with any training and coordination relative to this program area.

IMPLEMENTATION DATE:

9/30/2017

RESPONSIBLE OFFICIAL(S):

Director, Withholdings & International individual Compliance Practice Area, LB&I

Director, Criminal Investigation, Financial Crimes

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.

RECOMMENDATION 2:

The Deputy Commissioner for Services and Enforcement should take action to provide, updated guidance to reflect the documentation requirements and tax treatments needed for the various uses of virtual currencies.

CORRECTIVE ACTIONS:

IRS agrees that additional guidance would be helpful. Guidance allocation decisions are based on available resources and other competing organizational and legislative priorities (such as guidance to implement enacted legislation). We will share this recommendation for guidance with the IRS Office of Chief Counsel for coordination the Department of Treasury Office of Tax Policy.

IMPLEMENTATION DATE:

12/30/2016

RESPONSIBLE OFFICIAL(S):

Director, Withholding & International Individual Compliance Practice Area, LB&I

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.

RECOMMENDATION 3:

The Deputy Commissioner for Services and Enforcement should revise third-party information reporting documents to identify the amounts of virtual currency used in taxable transactions.

CORRECTIVE ACTIONS:

As part of our overall strategy development in response to Recommendation 1, IRS will consider whether changes to information reporting documents would assist in identifying non-compliance related to virtual currency transactions, Any changes will need to be assessed for cost to IRS and the payors who file these information returns, as well as taxpayer burden. However, in our current fiscal climate, the IRS is faced with competing funding priorities; and this reduced funding has required a need-based prioritization of Information Technology expenditures. Modifying information reporting documents to capture virtual currency amounts is not a priority at this time.

IMPLEMENTATION DATE:

N/A

RESPONSIBLE OFFICIAL(S):

Director, Withholding & International Individual Compliance Practice Area, LB&I

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.