It was recently reported that the IRS filed a petition in US federal court seeking full disclosure of Coinbase’s American customers records over just two alleged cases of tax avoidance by users of the bitcoin exchange. The summons came shortly after the Treasury Department’s inspector general issued a report chastising the IRS for not taking more aggressive action to curb “unlawful activities by those who use virtual currencies.”

While there are still so many discrepancies about how best to identify Bitcoin and how cryptocurrency gains and losses should be recorded and filed during tax time, more questions remain. How best can users follow such underdeveloped guidelines without getting into trouble? What potential solution could support those who have acquired a substantial amount of Bitcoin and want to prevent undergoing a tax evasion?

We turned to an experienced cryptocurrency expert for his take on the matter. Computer Engineer Perry Woodin is the CEO of Node40 – an incentivized infrastructure service that provides financial insight for cryptocurrency consumers. He identifies the problems with the current system which led to users being investigated and poses a two-fold solution to this problem.

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The problem

“Buying bitcoin is certainly not probable cause for assuming an individual is evading taxes. It is perfectly reasonable that an individual purchased bitcoin from CoinBase and has held it – meaning the purchaser has not realized any gain that can be considered taxable.

The summons from the IRS is as follows:

The IRS has launched an investigation to determine the correct federal income tax liabilities for taxable years 2013-2015 of United States taxpayers who have conducted transactions in a “convertible virtual currency” as that term is defined in IRS Notice 2014-21. The taxpayers being investigated have not been or may not be complying with U.S. internal revenue laws requiring the reporting of taxable income from virtual-currency transactions.

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It is most certainly the case that a number of Coinbase customers have bought AND sold bitcoin. In so doing they may have experienced a gain or loss. It is my understanding that the gain/loss is subject to reporting.

Part of the problem here is that reporting requirements aren’t exactly clear and compliance is very complicated. Buying 1 bitcoin in 2014 and selling in 2015 is rather straightforward. There was either a gain or a loss on the sale. However, once you start selling off bitcoin that was purchased or received on different dates, the value of each input comprising a transaction is subject to a gain or a loss. Only the most tech savvy individuals can accurately calculate the values necessary for reporting to the IRS. So we have a requirement to comply without guidance.”

The solution

Woodin believes that the IRS needs to first update its tax guidelines, but secondly, a software system or computer protocol needs to be developed so that any user or investor of cryptocurrency can compile a report at the end of the fiscal year, showing unrealized gains and losses from their entire virtual currency portfolio, and hand it to their accountant in a format that is easily understood, consistent, and accurate; one that would become a national standard.

“If the IRS wants to reduce non-compliance, two things need to happen:

1) The IRS must update its tax guidelines. The Treasury Inspector General for Tax Administration (TIGTA) proposed three recommendations revolving around new strategy, better guidance and revised third party reporting documents, to which the IRS have already agreed to implement.

2) Tax software will need to be upgraded so that any user or investor of cryptocurrency can compile a report at the end of the fiscal year, showing unrealized and realized gains and losses from their entire virtual currency portfolio.

Calculating accurate gains/losses on bitcoin transactions is exceedingly complicated. My belief is that people generally want to comply, but the burden is so great that people are either not reporting or are inaccurately reporting. They are not investing in bitcoin as a way to shirk tax obligations as the IRS summons seems to imply. The issues around compliance will be remedied, but it is going to require guidance from the regulatory authorities along with a technological solution that removes the barrier of accurate reporting.”