IRS continues targeting virtual currency

The Internal Revenue Service (IRS) continues to expand its compliance efforts related to virtual currency. A Massachusetts federal judge recently authorized a John Doe summons enabling the IRS to subpoena virtual currency records directly from certain exchanges. In addition, the IRS launched program Operation Hidden Treasure to identify and combat serious noncompliance through virtual currency transactions.

Key takeaways

  • To increase taxpayer compliance in reporting and paying tax on virtual currency transactions, the IRS is using a variety of tools, including court-ordered John Doe summons and a new Operation Hidden Treasure program.
  • Virtual currency exchanges are being ordered by courts to supply the IRS with specific taxpayer-related data. The IRS then uses this information to locate and contact taxpayers in an effort to collect unpaid taxes.
  • Through Operation Hidden Treasure, the IRS will identify tax evasion with virtual currency. Both civil and criminal cases will be pursued.
  • Taxpayers should monitor and contemporaneously document virtual currency transactions and provide relevant data to their tax preparers and include on their annual tax return.


Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value. In certain circumstances, it operates similar to government-issued coins and paper money, like what is issued by the Federal Reserve in the United States, but does not have legal tender in any jurisdiction. Virtual currency that has an equivalent value in physical currency is known as “convertible” currency (e.g., Bitcoin).

Instead of being issued by a national government or bank, this is purely an unregulated, electronic form of currency. It can only be transacted though certain designated software, mobile or computer applications. It is typically held within a blockchain network in digital wallets.

Private issuers, developers or organizations can create and issue their own forms of virtual currency. The use of such currency can be restricted to a specific online community or it can be made available to the public. A virtual currency’s value is generally derived on some underlying mechanism or asset (which can lead to significant fluctuations in value).

The IRS taxes virtual currency as property. Gains or losses are recognized on the sale or exchange of a virtual currency, including when a virtual currency is converted in order to purchase goods, services or other forms of currency. The IRS believes there is a substantial amount of virtual currency transactions not reported via third parties (i.e., reported on Forms 1099 or 1098). Regardless of whether third-party documentation exists, taxpayers must still disclose such activity on their tax return in the year of transaction. The 2020 Form 1040 has a question for taxpayers regarding their use of virtual currency. Since a significant number of these transactions seem to go unreported by taxpayers each year, the IRS is expanding its investigation and accumulating necessary data to bring taxpayers into compliance.

John Doe summons

Given the sheer number of virtual currency types and their increasing usage, the IRS has been targeting certain cryptocurrency exchanges, requesting specific data about a subgroup of their account holders in order to locate those taxpayers who are underreporting the tax on their transactions. The Internal Revenue Code allows the IRS to ask a court’s permission to obtain tax-related information when the taxpayer’s identity may not be known, otherwise known as a John Doe summons. However, in order to protect taxpayers, a John Doe summons generally must be narrowly tailored to meet the IRS’ specific needs. While not all John Doe summons are successful, in the past few years, the IRS has received authority to investigate virtual currency exchange Coinbase as well as Circle Internet Financial with a pending one for Kraken.

Data requested by the IRS in these John Doe summons, specific to virtual currency, typically includes six categories of records on U.S. account holders with accounts worth at least $20,000 between specific years:

  • Account registration records
  • Know-your-customer due diligence
  • Account-related correspondence
  • Anti-money-laundering exception reports
  • Account activity records, including date and times, amounts, U.S. dollar value, transaction ID, blockchain addresses for units transferred in and out
  • Account funding records

In certain cases, courts have stipulated further narrowing the above categories before allowing the IRS to proceed. These John Doe summons permit the IRS to order these virtual currency exchanges to provide the specified information. The IRS then contacts the respective taxpayers, usually starting with CP 2000 letters. Taxpayers respond by filing amended tax returns or settling through IRS examination. In some cases, criminal investigations are started.

Operation Hidden Treasure

The IRS designed Operation Hidden Treasure to identify tax evasion with virtual currency. The program falls under the IRS Office of Fraud Enforcement (OFE) and is a partnership with the Criminal Investigation division.

The IRS is working with third-party vendors to analyze the blockchain and identify parties associated with “signature” transactions to ultimately track and seize virtual currency in both civil and criminal contexts. Whether the signature transactions constitute those found in other areas of financial crimes, such as through structuring cash deposits or utilizing shell companies or nominees, remains to be seen.

Operation Hidden Treasure represents a culmination of previous IRS efforts to enforce compliance for virtual currency transactions. In 2018, Coinbase provided the IRS with the identities of over 13,000 account holders. About a year later, the IRS issued approximately 10,000 soft letters to virtual currency holders as a warning to come forward and report any noncompliance before the IRS initiates an examination.

Operation Hidden Treasure will pursue both civil and criminal cases. In civil cases, the IRS may assert a civil fraud penalty that equals 75% of the understatement of tax. To assist on the civil enforcement side, the IRS expanded virtual currency training to an additional 200 employees outside of the OFE to spot issues and effectively approach taxpayers and representatives.


Understanding your investment and usage of virtual currency is becoming more important as the federal government expands its efforts to hold taxpayers accountable. As part of gathering annual tax return information, taxpayers should review and contemporaneously document their virtual currency holdings and transactions in order to minimize getting caught up in these IRS enforcement programs. Relevant data should be provided to tax preparers during the course of the tax return preparation.

For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Brad Polizzano
American Rescue Plan direct small business assistance
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