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Cryptocurrency Tax Enforcement May Soon Reward Tipsters Through Whistleblower Program and False Claims Act – JD Supra

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BakerHostetlerKey Takeaways
International and state authorities could soon bolster enforcement efforts by rewarding individuals who provide information about underreporting income on virtual currency transactions. As a result, digital asset investors and their tax advisors could find themselves subject to liability under yet another regulation creeping into cryptocurrency governance. Taxpayers who skirt tax payments on virtual investments could be exposed to both criminal and civil liability under state False Claims Acts (FCAs). Specifically, Delaware, Florida, Illinois, Indiana, Nevada, New York, Rhode Island and Washington, D.C., authorize state FCA suits based on tax liability for failure to report income and making false statements on those returns.
On March 23, 2022, New York Attorney General Letitia James warned, “The consequences of a taxpayer’s failure to properly report income derived from transactions involving cryptocurrency are potentially far-reaching and severe.” The New York FCA allows for recovery up to three times the damages (two times the damages for voluntary and immediate self-reporting of fraud) and civil penalties of $6,000 to $12,000 per violation in addition to attorneys’ fees and costs – higher than the federal FCA, which allows for $5,500 to $11,000 per violation1.
Historically, whistleblowers have been extremely helpful in identifying and pursuing FCA violations, perhaps motivated by state FCA qui tam provisions that allow whistleblowers to share in potential recovery awards. Whistleblower tips in this area may become even more commonplace if, as is currently being contemplated, the Joint Chiefs of Global Tax Enforcement (J5) adopts a whistleblower program to boost its own enforcement efforts. The J5 has launched its own coordination event to target non-fungible tokens and decentralized exchanges. Further, the blockchain technology itself, which publicly records digital asset transactions, now allows the government to independently test the veracity of whistleblower claims and zero in on egregious violators.
The underreporting of virtual currency transactions is also a target of the IRS. The 2021 IRS Form 1040 prominently includes the question, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” right at the top of the first page. While the federal FCA explicitly excludes tax cases, the IRS and the U.S. Department of Justice (DOJ) have made no secret of their efforts to address tax fraud through criminal prosecutions. The Internal Revenue Code provides for a 75 percent civil penalty for any underpayment of taxes attributable to fraud. Even if fraud cannot be established, penalties for failure to report income or for underreporting income could apply. On Feb. 15, 2022, the IRS also released its revised Form 14457, which now allows taxpayers facing criminal tax issues to disclose all domestic and foreign noncompliant currency either directly owned or controlled by the taxpayer or of which the taxpayer was the beneficial owner.
Federal policymakers are also focusing on digital assets and their potential for tax avoidance. The 2021 Infrastructure Investment and Jobs Act included a provision to require digital asset brokers to report, for federal tax purposes, the transfer of digital assets to non-brokerage accounts (i.e., a digital wallet). The White House also recently included proposals in its 2023 fiscal year budget aimed at identifying taxpayers with digital assets and ensuring their appropriate reporting for tax purposes. These proposals include requiring (1) digital asset brokers to report information relating to substantial foreign owners of passive entities holding digital assets and (2) U.S. taxpayers to report certain foreign accounts that hold digital assets in excess of $50,000. These developments suggest that further Treasury regulations and IRS pronouncements regarding cryptocurrency reporting are forthcoming. With increasing coordination and information sharing among federal, state and non-U.S. tax authorities, taxpayers should be mindful of their reporting requirements and determining what is a reportable transaction, including when:
Crypto gains and losses should be reported on Form 8949, which requires the name of the cryptocurrency; purchase date; purchase quantity and price; date sold, traded or disposed of; sale price; and market value of the digital asset at the time of sale.
The BakerHostetler Tax Practice Group provides clients with sound and practical advice in federal, international, tax controversy, employee benefits, private wealth, tax-exempt, and state and local matters. Their experience extends to structuring transactions and representing clients in the course of an IRS examination. The Criminal Tax Defense team assists individuals and institutions with assessing and identifying issues of concern and implementing measures to reduce potential exposure. The team has successfully represented clients at each stage of the criminal tax process in administrative IRS investigations, joint IRS-DOJ grand jury investigations, and indictments and prosecutions by U.S. attorneys’ offices. The Blockchain Technologies and Digital Assets team has members across all of our core groups, and our attorneys have extensive experience across all sectors of the blockchain and cryptocurrency markets, including investigations, securities law, commodities law, Bank Secrecy Act/Anti-Money Laundering compliance, tax, privacy, transactions, advertising law, intellectual property and technology design, as well as government affairs, public policy, and advocacy across federal departments and agencies and Congress.
[1]The New York FCA can be used for tax fraud only if the defendant has “net income or sales” of $1 million or more and damages as pleaded are greater than $350,000.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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He is currently Editor at Inferse.com. He is a political columnist for the Finger Lakes Times, Eiram.org, and is the co-founder of InFocus.co. His passions include politics, golf, the media, and gadgets.