When the IRS first announced that a question would be added to Form 1040, Schedule 1 regarding virtual currency, observers speculated that the IRS might make use of the answer to this question to aid in tax evasion cases.  A special agent in charge at the Los Angeles Criminal Investigation Division (CID) was reported to have confirmed this view when speaking at the University of Southern California Gould School of Law Tax Institute per an article published in Tax Notes Today Federal.[1]

Schedule 1, Form 1040 for 2019 contains the following question regarding the taxpayer’s ownership, sale or exchange of virtual currencies:

At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?

Following the question are checkboxes labeled “Yes” and “No” that the taxpayer must answer if either of the following are true per the form instructions:

• The taxpayer is otherwise required to file Schedule 1 to report income or adjustments on his/her return or

• The answer to the question is yes, even if the taxpayer is not otherwise required to file Schedule 1 with his/her return.

Special Agent Ryan L. Korner is cited in the article with the following observations on the use of that information by the IRS Criminal Investigation Division:

In the case of the new checkbox, he said, CI could be alerted to an individual who checks “no” but who is shown in a different data set to have had millions of cryptocurrency transactions last year.

“We’re trying to catch the egregious offenders, and that’s just another line on a tax return that could potentially be a materially false statement and aid a criminal case,” Korner said.[2]

Special Agent Korner described other types of cross referencing the IRS CID has used or plans to use to find tax cases, including cases regarding tax professionals that are referred to the IRS Office of Professional Responsibility.

As has been noted on our website before, the IRS has had success in court using what turned out to be false answers to the questions regarding foreign bank accounts at the bottom of Schedule B to successfully show willful failure to file the foreign bank account reporting forms, applying the higher penalty for willful failure to those taxpayers.  In such cases, taxpayers have been unsuccessful in arguing that their preparer checked those boxes and that they hadn’t read the return—the courts have held that taxpayers have a responsibility to read the return even if it is prepared by someone else and they personally are held responsible for the answers on the return.

It remains to be seen if the courts will apply the same standard in the criminal tax context, but it seems at a minimum the answer to this question could be seen as providing evidence of fraud for applying the fraud civil penalties.  And it certainly would be far from helpful if the IRS was pursuing a criminal case, even if the courts demand more specific proof of criminal intent on the part of the taxpayer.

Despite the fact that many clients will have little or no idea what a virtual currency is, advisers need to make specific inquiry of all clients on this question.  A default “no” answer when the IRS is aware, from data they have received from exchanges, that the taxpayer has such virtual currency could subject the client to an IRS exam or worse.  

[1] Wesley Elmore, “Cryptocurrency Checkbox Could Aid IRS in Finding Tax Criminals,” Tax Notes Today Federal, January 30, 2020, 2020 TNTF 20-4, https://www.taxnotes.com/tax-notes-today-federal/cryptocurrency/cryptocurrency-checkbox-could-aid-irs-finding-tax-criminals/2020/01/30/2c3y9 (retrieved January 30, 2020, subscription required)

[2] Wesley Elmore, “Cryptocurrency Checkbox Could Aid IRS in Finding Tax Criminals,” Tax Notes Today Federal, January 30, 2020