Are Bitcoin Transactions Taxable?

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In an IRS audit today I was amused by all the preliminary questions about income sources.  The auditor asked about wage income, 1099 income, interest, dividends, royalties, alimony, child support, law suit settlements & awards, reimbursements, gifts, inheritances, grants, scholarships, life insurance proceeds, tips, etc., etc.  But the one thing she failed to ask about was digital currencies, like Bitcoin.  And I don’t mention this because I think the auditor missed something or that the client failed to report all his income.  He probably wouldn’t even know what Bitcoin is.  I mention this to illustrate the fact that the IRS has been slow to recognize digital currencies as income and/or supply guidance as to the specific reporting requirements.  But they’re going to have to act on this soon because it is becoming more prevalent:

In the four months between July and December 2013, bitcoin usage has increased by over 75 percent — from about 1,700 transactions per hour to over 3,000.  Over the same period, the market value of bitcoins in circulation increased more than ten-fold from about $1.1 billion to $12.6 billion.  Over 10,000 businesses reportedly accept payment in bitcoin.

~ TAS 2013 Annual Report to Congress

The only guidance (if you can call it that) from the IRS is found on a single web page on irs.gov entitled “Tax Consequences of Virtual World Transactions.”  The IRS essentially likens virtual currency to bartering, gambling, and hobby income:

The IRS has provided guidance on the tax treatment of bartering, gambling, business and hobby income – issues that are similar to activities in online gaming worlds.

It’s clearly not the same thing.  Legitimate law abiding geeky businesses (and individual geeks) deserve some more guidance from the IRS on this issue.

IRS Tax Scam Tips

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Every tax season the IRS warns taxpayers of tax-time scams and how to avoid them.  The IRS says that “tax scams proliferate during the income tax filing season.”  This year the filing season begins January 31st.  I hope taxpayers take this to heart, but I also hope that they remain vigilant throughout the entire year.

People often ask me if business picks up during tax time, and I usually explain that the IRS’ collection machine runs 24/7 and 365 days per year.  The IRS Collections Department doesn’t really have a “season” so to speak; they work year-round.  We do tend to get more phone calls during the first few months of the year, but this is due to the fact that the tax season is when people tend to think more about their tax issues.  The thought of having to file income taxes again naturally leads to the next thought of having to do something about the prior tax years and tax debts already on the books.

I suppose that a similar phenomenon occurs with tax scammers.  They definitely do their dirty work around the clock and any time of the year.  But they know that they will have more success during the income tax filing season.  Poor, unsuspecting taxpayers are just more likely to pick up the phone, divulge confidential information, and open spammy emails during this time of year.

The common-sense advice that the IRS gives each year can be summarized as follows: Don’t give out your personal information such as passwords, PINs, credit card or bank info via emails or over the phone.  This is not how the IRS operates, and if you do get a phone or email request for such information, it is probably a scam.

FTB Holding $16 Million in Returned Tax Refunds

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When you move to a different residence, do you immediately contact your creditors to let them know where you are?  Suuuure you do.  When you get around to it…

It’s no secret that some people spend their lives moving from place, just one step ahead of the IRS or other taxing agencies.  Although certainly not advisable, some people have good reasons for keeping their location a secret.  And then there are the others.  The brilliant 45,000 or so people in California who haven’t claimed their prior year state refund(s) yet.  The refund amounts range from $1.00 to $54,000.00 (total more than $16 million), and a majority of these people simply moved and didn’t update their address with FTB.  In other words, it isn’t so much that they haven’t claimed the refunds, but they were returned by the Postal Service due to the FTB having a bad address.

There is an easy fix to this problem.  Keeping your address up-to-date would be one way, but there is an even better fix.  DIRECT DEPOSIT.  If you use direct deposit for your tax refund, you get your payment so much quicker, and if you move you still get paid right on schedule (assuming you didn’t change banks).

Testing My Theory

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Apparently it wasn’t only me who thought the new Practitioner Priority Service (PPS) guidelines were ambiguous.  I don’t think the PPS customer service reps understand them either.  The best I could tell, I thought that they would be checking qualifications more closely, maybe even refusing to speak with anybody lacking a duly executed power of attorney.

It wasn’t long before I was able to test my theory.  Here’s how my first post-Jan. 6th PPS call went:

IRS: “How can I help you today, Mr. Wetenkamp?”

ME: “It’s my first call on this case; can you just give me an account overview such as balances due, missing returns, collection status, etc.?”

IRS: “Oh no, we can’t help you with that sort of thing anymore.  As of January 6, 2014 we are only allowed to assist you with active tax issues.”

ME: “WELL THEY DO OWE TAXES, DON’T THEY?!”

IRS: “Uh, . . . well, . . . yes.”

When the IRS makes informal procedure adjustments it is usually impossible to tell how they will materialize at the individual call centers.  For one thing, call center managers do not always interpret internal memoranda uniformly, so it is common to have slight variations from one city to the next.  But even if all IRS managers agreed, something inevitably gets lost between the team meeting where the memo is thoroughly explained and the cubicles of IRS rank and file.  You’ve probably heard anecdotally that the IRS doesn’t follow its own rules.  Well, this is precisely where it comes from and it happens every single day.

 

Changes Announced for PPS Phone Line

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Now I know why the hold times are so long when I call the IRS.

Some people think tax attorneys have a special dedicated phone line at the IRS and we can simply pick up and talk to whomever we want whenever we please.  This couldn’t be further from the truth.  Yes, we do have a special practitioner phone line, but during peak call times I don’t think it makes much of a difference, at least not lately.  The IRS Practitioner Priority Service (PPS) phone line has, in my opinion, never been the same since the government shutdown in October 2013.

The IRS recently announced some changes to PPS.  The IRS says that effective January 6, 2014, they will only be able to help tax professionals with tax questions through the PPS phone lines.  You have to be kidding me!  Isn’t this the whole point?!  What this means to me is that I have consistently been waiting on hold for an hour each time I call because the IRS Practitioner Priority Service number phone reps have been taking calls from non-practitioners with irrelevant questions!  This is beyond annoying.

This is all a little tongue-in-cheek because I think what the IRS really means is that PPS reps are going to be checking to see if the practitioner has a valid Power of Attorney on file for the account they want to discuss before answering long-winded questions that have nothing to do with specific taxpayer issues.

Also, the service is no longer going to honor live telephone transcript requests.  This makes sense because there are so many other ways to obtain transcripts such as through the automated phone service, irs.gov website, and by mail.  There is no sense in clogging up the practitioner phone lines with unnecessary requests.  I wonder if the hold times will get any shorter after January 6th.  One can only hope.

IRS Updates Pub 17 Tax Guide

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The IRS has made its annual updates to the Tax Guide (Publication 17).  Pub 17 is a virtual tax bible which has been available to taxpayers since the 1940s.  It contains just about everything you would need to successfully file your own taxes if not ensure your eternal salvation.  It is also somewhat biblical in length at 292 pages.  If you’re a do-it-yourself type person then you may be able to file your taxes without paying a tax professional this year, but you’ll have to start reading now.  Here is a brief outline of what you can expect to find in the new 2013 version*.

1. The Income Tax Return

Part one contains information about who needs to file, how to file (filing status selection), what forms to use, who can be claimed as dependents, etc. It also covers tax withholding and estimated tax requirements.

2. Income

The general rule is that you have to report and pay taxes on all income.  Part two delves into what is and what is not considered income.

3. Gains and Losses

Part three discusses investment gains and losses, including how to figure your basis in property.

4. Adjustments to Income

5. Standard Deductions and Itemized Deductions

6. Figuring Your Taxes and Credits

I always thought the Tax Guide was an odd (maybe archaic) sort of publication.  If you think about it, tax attorneys, accountants, and tax preparers have most of this stuff down pat, and the do-it-yourselfers are using tax software to prepare their returns.  However, it is a good reference tool.

Continue reading “IRS Updates Pub 17 Tax Guide” →

New Commish, 2014 Tax Season, EITC

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A few noteworthy events caught my eye in the world of tax relief today.

First, the Senate approved Obama’s nomination of John Koskinen in a 59-36 vote, confirming him to fill the top position at the IRS; a position that has been vacant for over a year.  Commissioner Koskinen will take his post beginning next week and we’ll definitely keep a close eye on him to see if he will fulfill his promise of restoring public trust to the agency that has been fighting a dismal public perception for years.  Obviously, this is not something that he’ll be able to do overnight.

Second, the IRS announced that the opening of the 2014 tax season will be on January 31st.  This is when the IRS will begin accepting 2013 tax returns.  The IRS encourages taxpayers to file electronically.  If you are due a refund, this is definitely the quickest way to get it.  Also, the IRS reminds us that we always have the option of requesting an automatic six-month extension using Form 4868.  The IRS tends to encourage extensions because it spreads out the influx of tax returns so that things don’t get too bottlenecked.

And finally, TIGTA, the IRS watchdog, reported on increasing abuse of the Earned Income Tax Credit (EITC) by tax preparers.  The IRS has always had a problem with EITC abuse and fraud because it is a refundable tax credit that can mean money in the pocket of whoever claims it and qualifies (or appears to qualify).  TIGTA noted that too many tax preparers fail to do their due diligence by completing and attaching Form 8867, the Paid Preparer’s Earned Income Credit Checklist.

1,168 IRS Contractors Owe Taxes

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In high school if you hang out with the “wrong crowd” you can acquire an unwanted label and perhaps an unwarranted reputation.  It’s funny how many high school parallels we find in the adult world.  Associating with the wrong business partners can also cause serious damage to your reputation and credibility.  If you continue to do business with unethical people, then it is not too much of a stretch to assume that you are guilty of similar unethical practices.

The IRS knows a little about this.  According to a recent TIGTA audit report, 1,168 IRS vendors owed back taxes totaling $589 million as of July 2012.  Now to be fair, the IRS screens the companies it intends to award contracts to, and the IRS will not work with them if they owe taxes.  However, they do not have a system in place for continued monitoring after the contract has been awarded.  Also, to be fair to these vendors, owing back taxes is not necessarily dishonest or unethical.  In fact, in my experience, most people that owe taxes are good citizens and businesses that have made honest mistakes, procrastinated, and/or that have fallen on hard times.

The statistics aren’t really as bad as they appear because there is one contractor who is responsible for a whopping $525 million.  Still, this is something that the IRS really needs to monitor closely.  We know how increasingly important public trust has become at the nation’s most troubled agency.

Criteria for an IRS Audit

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If you’ve ever been audited by the IRS then you would probably agree that it is one of the most stressful ordeals of your life.  Some people worry themselves sick about their potential for audit before they even hear from the IRS.  It is useful to understand some of the IRS audit selection criteria so you can deal with the things that are within your control and not worry about the things that aren’t.

The IRS tends to use the terms “exam,” “examination,” and “audit” interchangeably.  These are all terms they use for the process of examining, clarifying, and correcting errors on one or more tax returns.  As you can imagine, the IRS does not have the resources to carefully pick through each line of each return.  Instead, the IRS picks out certain returns with a high likelihood of containing errors, and these are some of the selection methods:

  • Computer Scoring:  The IRS’ Discriminant Function System (DIF) is a computer program that flags returns based on a numeric score.  A return that has a higher likelihood of problems (such as unreported income) gets a higher score.  Then the high-scoring returns are reviewed by human eyeballs and some of them are selected for audit.
  • Information Matching:  The IRS compares payer reports (1099s, W-2s, etc.) and public records to what is claimed on the tax return and may select returns for audit based on discrepancies.
  • Related Examinations:  If you are affiliated with people or entities that were selected for audit, your chances of being audited may be higher because when the IRS finds problems with one return, they have found that others may be lurking near.
  • Informants:  Some returns are selected for audit based on anonymous tips or are the result of extensive investigation into tax evasion schemes.
  • Large Corporations:  And finally, some large corporations must submit to routine examinations (often yearly) simply because they generate huge profits and the stakes are too high for the IRS to miss anything.

If you do get selected, you should know that the vast majority of audits are completed without ever meeting face-to-face with the IRS.  Here are the different types of audits:

  1. Service Center Examinations (very simple, few issues, math error or something of that nature)
  2. Office & Correspondence Exams
  3. Field Examinations (Revenue Agent goes to your home or place of business to physically inspect your books)

http://www.irs.gov/uac/The-Examination-(Audit)-Process