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Saturday, December 3, 2016

Can IRS Use Coinbase Order To Harass Bitcoin Owners?

The federal government might have a new tool to discourage Bitcoin investment and acceptance by retail merchants.

That's because a federal judge recently authorized an Internal Revenue Service summons on the digital currency exchange and wallet provider Coinbase for its transaction history for the three years prior to December 31, 2015.

This means that the granular information of those transactions, all investment purchases and sales as well as each merchant transaction, will be accessible to the IRS.

The summons itself does not change any tax liability or responsibility of American taxpayers, because digital currencies have been ruled to be currency since an early 2014 agency ruling.

But without Coinbase issuing detailed records of transactions to its customers, the granular information to the IRS means the agency may obtain the aggregate sale proceeds to customers and force the customers to rebut the agency position that those gross proceed amounts are not income. Unfortunately, that means customers and merchants would be compelled to go through the trouble of documenting (i.e., proving) their purchase price (their "basis" for tax purposes) in the digital assets, lest the IRS assume a zero basis and that the entire sale price is taxable gain! This is patently unfair.

Imagine a supermarket (to take a low-margin industry as an example) buying milk wholesale for $2.50 per gallon, selling it at retail for $3.29, but being taxed as if the entire sale price were profit?  Well, if you're a bitcoin investor or merchant who takes bitcoin as payment, that could be the unstated, de facto policy of the IRS. And that would be a hidden, unofficial, unspoken way for some government officials to discourage the use of digital currencies.

Yet all is not lost. Any smart merchant or investor should keep meticulous records. All customers will need their records of the purchases. This will establish the basis of the taxpayer.

Now I will explain why that is not necessarily bad. Indeed, with the long period of Bitcoin's price decline from its $1200-plus peak in late 2013 to its trough below $200 in late 2014, many sales in the covered three year period (Jan. 1, 2013 to Dec. 31, 2015) may have been at a loss, where taxpayers bought at a higher price than the sale. Bitcoin still is several hundred dollars below its peak. Many Coinbase users may have taxable losses on Bitcoin, and can use $3,000 of losses to offset other income, and losses over that amount to offset any capital gains.

The uncertainty about the IRS implementation of its enforcement powers, and whether Coinbase will issue the tax statements customary for securities broker dealers or mutual funds, means that taxpayers may have significant tax reporting burdens for which they are unprepared.

If Coinbase starts -- or is required -- to issue tax statements to customers like other financial institutions, Coinbase will need to be prepared for a new level of compliance and the resulting costs. Those costs naturally get passed down to customers. You could see annual account charges or higher transaction fees, and plenty of business moving to extraterritorial (outside the United States) exchanges.

Taxpayers with Coinbase accounts face a documentation problem and should strongly consider hiring a legal or tax professional knowledgeable in digital currency to help establish the evidence needed to prove their tax basis in Bitcoin and other digital assets.

Eric Dixon is a New York lawyer, blockchain enterpreneur and all-around fixer. Reach him at EDixon@NYBusinessCounsel.com.

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