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INSIGHT: IRS, Keep Your Hands Off My Virtual Assets

Oct. 21, 2019, 1:02 PM

In 1964, a Supreme Court Justice famously stated:

“I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description [hard-core pornography], and perhaps I could never succeed in intelligibly doing so. But I know it when I see it…”

When our government officials are unable to make clear definitions, people get hurt.

The Internal Revenue Service is busy revising form 1040 (Schedule 1 that is, not the postcard) preparing for the 2019 tax season, while many accounting firms struggle to close the books on 2018, and here comes another set of fun challenges for next year. The latest question, at any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency, seems harmless enough…right? Wrong.

This is starting to remind me of that apparently simple yes or no question on the bottom of Schedule B of the 1040, At any time during 2018, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country? Answer incorrectly and you may find, to your peril as some poor taxpayers did, that the judge and IRS think you were intentionally lying ... but I digress, you and your advisors would never make such a simple error.

If you look at the proposed definition in the IRS FAQs on virtual currency transactions, FAQ 1 may standout.

Q1 What is a Virtual Currency? Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency.

This broad definition of a virtual currency would certainly seem to include Bitcoin, Ethereum, Zcash, Litecoin and even Libra if that still exists at the time of the next tax filing deadline. But wait, how about my Delta Skymiles account or any on-line points program. Are air miles now going to be considered a virtual currency? Let’s see—is it:

  • Other than a U.S. Dollar or foreign currency?—check

  • A Unit of Account? 1.6 million of those hard-earned miles?—check

  • A store of value? Just got a free business class ticket to Johannesburg—check

  • A medium of exchange? Hmm, I can buy tickets, book a hotel room, buy flowers for my wife, give miles to charity, and fight over them in divorce proceedings—check

So, I am pretty sure the IRS did not think about this, but it looks like my Delta Skymiles are a virtual currency, Delta is my “Federal Reserve Bank” and I am pretty sure it does not end there.

Any big fans of on-line gaming, Second Life, Counter Strike Global Offensive, World of Warcraft, EVE online and many others are spending real and virtual money buying cool on-line real estate, weaponry, characters and a whole lot more. Are all of these on-line playgrounds now going to be considered in play for your next IRS audit? There are many more examples of “virtual currencies” that don’t seem to come under the umbrella of the cryptocurrencies that the IRS is trying to get a handle on.

Whether it is foreign bank accounts, virtual currencies, cash tips or babysitting money, the IRS certainly has the obligation to close the tax gap and ensure that U.S. taxpayers are reporting their income and that everyone is paying their fair share.

In the “Wealth of Nations” Adam Smith proposed four maxims with respect to taxes: Equity, Certainty, Convenience, and Economy.

Defining Wealth and Income is getting harder by the day, and the mountains of productive time being spent (wasted) on tax compliance is becoming a national crisis. Perhaps taxing consumption, a little more strongly, a flat income and FICA tax on business income and wages, and a great reduction in the size of the U.S. tax code would be a better virtual gift to the next generation.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Jonathan Lachowitz is a CFP® professional in the U.S. and Switzerland and founder of White Lighthouse Investment Management. He is specialized in cross-border financial planning and investment management and works with many multi-national families. He is the Chairman of American Citizen’s Abroad Inc., has written for financial news publications on personal finance, and has been an occasional lecturer at IMD and ESCP Business Schools.