Watch our latest Webinar on the IRS Cryptocurrency Enforcement policies of ‘Operation Hidden Treasure’

Streamed: Thursday August 26, 2021
Duration: 1 hour
Language: English

 


 

About This Webinar

This webinar will walk you through how the IRS approaches taxation when it comes to crypto, explain what constitutes a taxable event and provide tangible examples to guide you. It also touches on some emerging issues in the space including how to account for staking rewards, interest earned from lending activities, and even NFTs!

 


 

Webinar Transcript

Liz Prehn:
Hello, everyone. My name is Liz Prehn and I’m an attorney with Moskowitz LLP. Today we will update you on recent IRS initiatives related to cryptocurrency and how to handle IRS tax audits involving currency tax minimizing techniques to consider and other tax planning opportunities. Our presenters today are Steve Moskowitz, who is the founder of Moscowitz LLP, and a practicing attorney with over three decades of experience representing individuals and businesses with sensitive tax examinations and government investigations, tax preparation concerns and tax advisory. Steve is well respected for his expertise and judgment in handling matters arising from government ongoing enforcement efforts. He is a frequent legal commentator with various national media outlets.

Cliff Capdevielle is our managing attorney, and has been developing sophisticated tax planning strategies and resolving tax disputes for clients for more than two decades. As a lawyer, accountant, and long-term instructor, Mr. Capdevielle formulate strategies to utilize the ever changing array of federal and state tax laws to his clients benefits. We welcome you.

Steve Moskowitz:
Welcome to everybody.

Cliff Capdevielle:
Thanks, Steve. So Steve, here we are again and you’re barely old enough to remember when the IRS decided to go after foreign accounts in 2008 and 2009-

Steve Moskowitz:
I think I was in junior high school at the time Cliff.

Cliff Capdevielle:
eerily similar as you remember a lot of people 15 years ago really didn’t think the IRS could touch them if they had their money in Switzerland or other, at that time, tax havens, and people were very lax about the reporting. Many people didn’t understand the reporting obligations. Those who did thought that the IRS was not clever enough to figure out a way to get at their money, and what happened then Steve?

Steve Moskowitz:
Some people found the new home in the federal penitentiary, a lot of people were shocked when they lost incredible money to grossly disproportionate draconian penalties. And one of the things that struck me … all the things with the foreign bank accounts, is a major change in 2009. Now, the first law they enforce was a law that had been around since 1970 for FBARs, that was pretty much unenforced because the government had no way to do it. But what happened was, the Justice Department went after a big Swiss bank and the federal government was able to change famous Swiss Bank Secrecy law, and then the Swiss became super cooperative and became what was known as a Model 2 where they went ahead and became extra cooperative in providing the information after changing Swiss law.

The next year, the IRS said to the rest of the world, the rest of the world, see what we did to the Swiss, fall in line, and the taxing authorities in most of the world were happy for that, because basically what a lot of people did was just hid their assets in another country and they got away with it. For example, wealthy Mexicans were hiding money in the United States from the Mexican tax authorities using America, United States, as a tax haven. Those days are long gone. And most of the world is entered into an international sharing treaty where the governments exchange information now. So there’s reporting from financial institutions to the IRS, there’s reporting from governments to the IRS, and back and forth. An operation hidden treasure has piggybacked on this. When the IRS started the foreign bank account program, this was new territory, and they took a long time learning how to do this because these things were hidden, and they had to [fur] them out.

And basically what they’ve done with the operation hidden treasure for the crypto is they’ve taken an awful lot of what they’ve learned and gained from the foreign bank accounts and used it for crypto and what we’re seeing is this program is moving ahead much faster than the foreign accounts did. And again, there’s a lot of people that wrongly think that, oh, if they have the crypto, they’re going to hide it from the government and nobody will know. When in fact, there’s really a lot of good records available with crypto. And also the IRS has been successful through use of various summonses to get all kinds of information. So the bottom line is, if you’re holding crypto and you think that the government is not going to find out about it, it goes way, way, way back to the time before 1099 and people used to say, well, how would the government know where they were keeping their money in the bank account? That was before 1099s.

Nobody would think about that today because obviously the government is getting all the information in the bank. So that’s what’s happening with the crypto now. And is a amazing area, not to mention the fact there’s some complexities, and it’s not just, oh, dishonest people are hiding in crypto. What we have here is there’s a lot of good people that wouldn’t dream of violating any tax laws, they just want to step in and make the Boku profits that are possible, but don’t realize that they are inadvertently violating all kinds of rules, and the IRS is going to come with a heavy handed in this program. The bottom line is, regardless of what you’re thinking is whether you thought you were hiding some things, or you were just a typical investor in for the money, not realizing you’re making violations, we want to clean this up before the government comes calling. And as a general rule, you get a much, much better deal if the taxpayer goes to the government before the government goes to the taxpayer. And on that happy note, Cliff, I want to turn the floor back to you.

Cliff Capdevielle:
Thanks, Steve. So briefly, cryptocurrency is digital money. It is treated by the IRS as property, and we’ll talk about that in detail, but it’s encrypted and this is why so many people thought that maybe they wouldn’t have to report it because they were in a sense anonymized on the internet and there wasn’t a easy way for the IRS to get this information now. In the past few years, we’ve seen summons go out to coin base in other wallets, requiring those entities to turn over information to the IRS and the IRS has notified a lot of people that they have this reporting obligation and those amended returns are coming in, and Steve there’s a lot of clients now who are filing five, 10 years tax returns, as you said before the IRS gets to them in order to avoid more serious penalties, criminal penalties and other. So today we’re going to talk a little bit about how to do that, how to get yourself clean with the IRS if you haven’t been reporting your crypto transactions, what that means in terms of penalties, how to avoid penalties, etc.

Steve Moskowitz:
And also some people mistakenly think that the IRS is just too busy to get around to them. President Biden was concerned with this. President Biden wants to double, that’s literally double the number of IRS agents and give them a lot more money and a lot more equipment. And already as of the date of this webinar, the IRS has already added a lot more collectors and criminal agents and they’re promising to come knock on your door. You really don’t want that. You really want to have a good exit plan now while you still can.

Cliff Capdevielle:
So a little bit of terminology. What is Bitcoin? It is the first cryptocurrency and this was introduced in a paper about 12 years ago and it was called then a peer to peer electronic cash system. We’ll find out that the cash system is not quite accurate, the IRS treats it as property instead of cash. But Bitcoin is an electronic payment system. It’s based on cryptic graphic proof, which means that the transactions are verified and recorded, and that’s all done on what’s called a blockchain which is a ledger. So the transactions are all recorded in computer code and these are recorded in what are called blocks and that’s why we have the name blockchain linked together. All of these transactions are checked using two types of validation or proof, one is proof of work and the other is proof of stake. So what is this about? So proof of work, verification of the transactions with an algorithm and the computer essentially solves a mathematical puzzle, as a result of solving that puzzle, the participants are rewarded with a small amount of cryptocurrency. So that’s what this is. That’s how these

Steve Moskowitz:
Giving mining a whole new definition.

Cliff Capdevielle:
Pardon me. Giving what?

Steve Moskowitz:
Giving mining a whole new definition.

Cliff Capdevielle:
Absolutely. So we’ll talk about mining and why that’s important. So the proof of stake is a transaction where a person verifies the transaction with a little bit of their own cryptocurrency or a stake, and those people who are putting up that stake are then rewarded with additional cryptocurrency. So that’s a way to confirm those transactions and it’s more efficient than the proof of work. Steve mentioned mining, so what is this mining about? This is essentially validating transactions. And this is a way, again, that those owners of cryptocurrency can earn additional crypto currency, and this is all done course on mining computers. And Steve has a client right now who is busy building these mining computers all over the world, though this is turning into a huge business and a lot of people who were using cryptocurrency are also mining that. We’ll talk about how to do that.

So what do people use cryptocurrency for? Well, it’s used on the internet to make payments. You can pay Steve today in cryptocurrency. If you log on to his website, you can pay for tax return using cryptocurrency, you can exchange cryptocurrency for gift cards, you can buy big Bitcoin and use that to pay for transactions on the internet and then convert it back to US dollars. Some people are investing in cryptocurrency. They’re using this as an alternative type of investment just like many people have invested in gold and silver. Cryptocurrency is an alternative investment

Steve Moskowitz:
I think Cliff, it should also be pointed out that crypto is really becoming mainstream. When it first came in, people were looking as of something way out there. Now is something as common as PayPal. You can put in your Visa, you can put in your MasterCard, your checking account, or crypto. That’s how mainstream it has become.

Cliff Capdevielle:
Yes, absolutely. It is used all over the internet to pay for services, to buy assets. And how do you do that? Well, usually, it was done through what’s called a wallet, Coinbase is the most famous, but there are all kinds of peer to peer networks, or cryptocurrency exchanges. But nowadays, you can use a more standard investment vehicle, Robinhood, for example, has an app that you can use, there are mutual funds now trading in cryptocurrency and even Bitcoin mining stocks. So there’s a lot of ways to invest in cryptocurrency compared to just a couple of years ago.

Now we get into taxes. So the big question for everybody on this webinar is, how is crypto currency taxed? Well, interestingly, it’s not taxed as money. It’s taxed as property. What does that mean? Well, if you bought a piece of real estate, for example, and you sold it, you would be taxed on the difference between what you originally paid for that property and what you sold it for. That is exactly how cryptocurrency is taxed. So if you were, for example, just trading cryptocurrency, the tax would be based on the difference, what you paid for that Bitcoin and what you sold it for.

But it gets more interesting when you use cryptocurrency to pay for goods or services. Why? Because there are two, essentially two transactions. There is that payment, and you would include in your income the difference between what you originally paid for that cryptocurrency that you used for payment and what you traded it for. So if you buy goods on the internet, or you pay for services with cryptocurrency, that is a taxable transaction. So the difference between what you originally paid for that virtual currency and the value of the goods or services on the day that you made that transaction is taxable-

Steve Moskowitz:
And in practice, a lot of people have a problem with that concept. They can’t understand it. So the way I’ll explain it to clients is think of it like this. You stopped off at the stock broker, sold some stock, he or she gave you the cash, and that’s what you spent in the grocery store. The crypto essentially does the two transactions in one in the grocery store. That’s the way you have to conceptualize it to think of it because a lot of people don’t really get that and that they trip up, good honest people trip up there.

Cliff Capdevielle:
Yes, it’s not obvious, because when you pay for groceries at Safeway, that’s not a taxable transaction if you’re using US dollars. So the idea that you would actually be taxed when you make a payment is a new concept for most people. So how do we determine then what is the fair market value of that virtual currency? And you’ll have to translate that into US dollars and that’s typically going to be information that you get on the exchange. What happens if you exchange virtual currency for other property? And that is, of course, a taxable transaction. So this means that if you’re exchanging Bitcoin, for example, for another cryptocurrency, that, again, is a taxable transaction. And if the value of that property that you’re exchanging the cryptocurrency for is less than the fair market value of the property, the cryptocurrency, then you’re going to have a gain, and if you exchange a cryptocurrency that has declined in value, you’re going to have a loss. So this is … it requires additional record keeping and most most of the wallets now capture that, but if you’re trading outside of one of the commercial wallets, you’ll have some record keeping to do.

Steve Moskowitz:
And also watch out if you have a foreign wallet. There’s all kinds of special foreign rules there.

Cliff Capdevielle:
Sure. So that’s an interesting question is if your assets are off shore, do you have foreign reporting requirements according to FATCA, the answer is probably yes. So what is mining? We talked about that a little bit earlier. So the mining is taxed as if you are receiving an asset. So the mining of virtual currency is taxed like a business and so to the extent you receive virtual currency and payment for mining operation that is included in your gross income. Now you may have offsetting expenses associated with that mining activity, it can be very expensive to run these machines, so the cost of your computers and the energy to run those computers, those are all tax deductible business expenses.

Is that subject to self employment income? And it is. So this comes as a surprise to many people that they would be subject to Social Security and Medicare tax on their cryptocurrency income. But if you are using your own hours to mine or stake, that is all income that is subject to self employment, that’s different from trading activity. So if you’re trading cryptocurrency, if you’re buying and selling in the US dollars or you’re trading one cryptocurrency for another, that typically will be taxed like an investment and not be subject to self employment tax, unless that’s your primary way of earning a living, and then that also could be subject to self employment tax.

Liz Prehn:
Cliff, we have a question here as, where do we need to report the gains on the tax return? I think this is coming from an individual.

Cliff Capdevielle:
Okay, so good question. And the gains or losses are reported on Schedule D in form 8949, just like a stock transaction. So for example if you’re selling Bitcoin, you would report the sales price, and then you would report your original purchase price, and that difference is a taxable gain on Schedule D. So what do we have to do in terms of reporting if we pay someone? So it’s very similar to the rules that require reporting if you pay somebody in cash. If you have a contractor working for you, and you pay them in any one year, more than $600, you have to report that on a Form 1099, and that, of course, requires that you gather the Social Security or employer identification number from that person and then you mail that or file that 1099 with the IRS, and that person who’s been paid in cryptocurrency then has to report that income on his or her income tax return.

Liz Prehn:
And Cliff, what are … and I might be getting ahead of you here, sorry. What are eligible deductions related to this line?

Cliff Capdevielle:
Sure. So depends on what kind of transaction it is. If it’s your business, if it’s self employment income, then you would be eligible for all the related business expenses. So if you have a home office, if you have computer expenses, you have utilities, all of those would be deductible against your taxable income if you’re running a business. If you’re trading as an investment, then of course the basis, what you originally paid for the cryptocurrency is deductible, as well as any brokerage fees, Coinbase fees, and any other sales expenses related to it.

Liz Prehn:
Okay. Thanks.

Cliff Capdevielle:
And obviously, we’re going to collect the taxpayer information, the social security or EIN number, and then if somebody is subject to backup withholding, we’ll have to report that as well. It wasn’t questioned until recently whether forks are a taxable event in this is when a cryptocurrency undergoes what’s called a protocol change and essentially creates a new bit of a currency and the IRS has a revenue ruling, and essentially if the taxpayer receives additional units of the cryptocurrency that is a taxable event.

Liz Prehn:
How about if you’re paid with crypto, but there’s no exchange information?

Cliff Capdevielle:
Yes, so if you’re paid through cryptocurrency, you do have an obligation to report that, whether or not the payor issues you a 1099. If you’re using one of the major wallets, like Coinbase, they will give you a report at the end of the year and if you purchased the crypto through that wallet, or if they have that information, that will show up on the [inaudible] report as well just like a 1099. The big news of course, the IRS Treasury has announced that they intend to make this a requirement going forward so that all of these wallets will essentially have to operate like your retail brokerages and issue you a 1099 each year, airdrop, same thing. If you received a new cryptocurrency following a hard fork, that is a taxable event.

So what happens if you want to cash out? Well, you can, for the most part, cash out your virtual currency converted back to cash, that will constitute a taxable event. You might think, well, just exchanging one currency for another, why would that require a tax reporting? Well, the IRS treats the cryptocurrency as property, and when you convert that to cash, that is taxable event. And what does the Bank Secrecy Act require? Well, I’m going to let Steve talk about the history of FinCEN and the Bank Secrecy Act, but the bottom line is that the SEC and the IRS are going to require reporting, and Steve, why don’t you describe a little background about FinCEN and [crosstalk]

Steve Moskowitz:
This came into light in the 1970s in South Florida, when there were allegations that the banks there were major launderers for South American drug money that was coming in the country, and there’s lot of cash transactions done. So what happened was the government said, well, okay, if you are dealing in more than 10,000 currency, there’s a special report that has to be made. So if you go ahead and you buy something for 11,000, the recipient has to go ahead and within 15 days, report that to the IRS. And they get even very, very detailed in the reporting. So then some people said, well, okay, how about if they give you 9,000 today, and next week, they’ll give you 2,000, so it’s under 10,000? And although technically that worked initially, the government came out to count that with what’s called structuring loss.

So if you try to avoid the reporting by breaking it up into amounts in less than 10,000, you’ve committed that felony. So the bottom line is all of this, and it all fits under the whole rubric, where people were trying to do transactions that would fly under the radar, do something other than a traditional write a check. And every time the government does something like fencing, play in counterplay, where the government comes up and says, no, you can’t do that, and if you do, it’s a crime. So the bottom line here is that the government has gone ahead and they try to thwart all that.

And again, what happens and what we saw in the foreign bank account area was … the government actually coined a new term called levels of connivance. And what happens is, the more the person tries to do to hide something from the government, the more the government will punish you. So the bottom line is, essentially, whatever you’ve thought up to try to get around these rules, somebody else on your side has thought up and has the punishments. The bottom line is attorneys are going to tell you comply with all laws, do what you’re supposed to and avoid all these things. However, if you’ve made some mistakes in the past, you still have an opportunity to … and there are government programs for those too, to come forward and say, look, you did something you shouldn’t have, you want to make it right, you want to have all forgiven. And those are good programs to get you out of trouble and some people really do inadvertently get themselves into trouble.

Cliff Capdevielle:
So bottom line is that virtual currency will be regulated by the SEC, in terms of investments in cryptocurrency and the other federal regulator. So there was, for a long time, kind of the feeling that cryptocurrency would avoid these kind of regulations, and it’s looking like they will be subject to the same kind of scrutiny as any other kind of investments and will be subject to the same reporting requirements.

Liz Prehn:
And Cliff, just to that, and do we know when officially third-party reporting is … I know some is taking place so far. But [crosstalk]

Cliff Capdevielle:
Probably 2022 will be the first year that the 1099s will be required.

Steve Moskowitz:
And also, very, very recently, as part of the Congress spending trillions of dollars in giveaways, there’s increased cryptocurrency reporting requirements coming up as well. So the bottom line is, everything we’re telling you today is good as of today, but the federal government in an effort to bring more money into the coffers because of all their spending on infrastructure, stimulus programs and all other kinds of things, one of the ways they’re trying to get it back is by looking a lot deeper at the crypto. So that’s coming up.

Cliff Capdevielle:
Right. And so for a long time, criminals exploited the privacy protection of crypto currency exchanges, and they were able to evade law enforcement, but that course came to a crashing and with the Silk Road arrests, as most of you know, that was arrest in San Francisco of a major cryptocurrency website, which allowed trading in illegal goods mainly drugs. So since then, of course, law enforcement been very interested in cryptocurrency. A lot of the criminals now are seeking workarounds. They’re generally not using Coinbase or the major exchanges, but law enforcement is obviously very interested in this and that brings us to the main topic today which is Operation Hidden Treasure, which is the criminal investigations unit crackdown on cryptocurrency tax evasion. So Steve, what happens when a client comes to you and they’ve been the subject of a criminal investigation? What does that client need to know on day one?

Steve Moskowitz:
First, they should talk to us and only us because as attorneys, we have attorney client privilege. If you fess things up to your CPA, your CPA can and will be called to testify against you. And if you’re the subject, then we take a look, are you a target, or are you a witness? The target is the person that the government’s trying to put in the federal penitentiary. A witness is somebody that they’re using to help them put the target away. However, you have to be very careful that the witness doesn’t turn into a target. And also when the investigation begins, CID, Criminal Investigation Division is making a decision of whether or not to prosecute these people. CIDs work comes into one of two conclusions: recommend for prosecution or not, with a slang term kick the case.

What we want to do is, in working with the CID people, make a decision … then remember, you have the right to remain silent. That’s a very, very important right. But is it worthwhile for you to give up that right to make a deal? Sometimes it is, sometimes it isn’t. And then what we want to do is initially work with CID, and see what type of deal can we construct? What can we do? How can we convince them to kick the case? That is the objective. Now remember, when it’s at the level of a criminal case, the government’s already done a lot of homework. If that government criminal agent knocks on your door, it’s not just a fact finding at that point. They think they have you.

They’ve done a lot of homework. It’s a very elite group and they really dig deep down in these transactions. So first, we want to try to convince them, hey, you have the wrong idea here. And if they go ahead, and depending on when the client comes to us, a further stage, if the agents decide that there is grounds, they will go ahead and refer the case to the national office in Washington, DC. If that happens, again, wherever we get involved in the case, obviously, we’d like you never to have this case, but if you do just like a medical problem, the earlier you address it, the better. But if you come to the next stage, then we’d actually have to go to Washington, DC, and see, can we convince the government that this is not the person you want to prosecute.

The next stage is with the National Office recommends prosecution, they send it back to the local prosecutors working with the local prosecutors, again, the whole idea what the lawyer is trying to do is make a deal so you’re not prosecuted. And if that doesn’t happen, then you go ahead and go to trial, and explain what happened to a jury. So again, there’s a tremendous amount here, but the bottom line is when you think of a legal case, think of it like the Olympics. It’s not the time you’re watching the running around the track on the TV. It’s all the work and sweating and straining before the event. That’s where the lawyer is really helping his client, going to talk to the government and seeing, what type of deal can we strike? How can we get our client out of trouble? It’s so vitally important.

Cliff Capdevielle:
So what are they looking for? They’re looking for structuring, they’re looking at Shell corporations, unusual deductions, any kind of account switching. Steve, what is structuring and why is the IRS interested in that?

Steve Moskowitz:
So structuring is where people are trying to get around the currency reporting laws. That’s where if you do a business transaction in excess of $10,000, you have to go ahead and do a special report. So suppose for example, you went to a jeweler, and you bought a $12,000 necklace for someone. If you went ahead and paid 12,000 in currency, that jeweler is supposed to say, okay, I need your driver’s license and I have to have some information from you. And then that jeweler has to file a form a Form 8300 and report to the government within 15 days, that John Smith customer purchased 12,000 in currency. Well, what if the person say, look, they don’t want that report written. So they say they’ll give you 9,000 today and 3,000 next week, because you’ve broken the transaction up to go ahead and avoid those cash reporting rules. You’ve committed the felony of structuring.

However, the government is looking at all these transactions. Never forget there may be a legitimate reason for doing that. Let’s go back to that same gentleman who walks into a jewelry store and buys a $9,000 necklace. Well, unless the recipient thinks it’s a suspicious transaction, that one does not have to be reported. And then next week, that same gentleman says, you know what, I would like to buy the matching earrings. How much are those? And the jeweler says, 3,000, the customer hands over the 3,000. Those are two separate transactions, very different from the first transaction where you took 12 and you broke it into nine and three. Structuring is a serious felony. The government takes this very, very seriously and you really, again, you don’t want to break any laws, you don’t want break [inaudible]. That’s what structuring is all about.

Basically the things you have here, there’s basic, we’ll call hiding. And, for example, Cliff, if you just go back to that previous slide for a second, I want to talk about Shells. And what happened is one of the things that the government is looking to, is going ahead and saying, well, wait a minute, you’re hiding things, the government is suspicious of that. And one of the things that the government has a crack down on is some people were buying luxury real estate, but not in their name, in a Shell company’s name. And again, in our country, it is very suspicious, when John Smith buys something in the name, anything other than his or her own. That’s one of the things you have to watch out for. And with these real property transactions, the government’s specifically looking at that, because that was one of the ways that people were hiding wealth and yet acquiring assets. So you take a look at that. And again, the purposes of it, why are they doing this? And oftentimes, there could be two purposes, one perfectly legitimate, form corporation for limited liabilities. People do that all the time. On the other hand, if you’re doing it to hide things, that’s where you get in trouble. But again, we could do a whole seminar just on that, and I’ll give the floor back to Cliff now.

Cliff Capdevielle:
Thanks Steve. So in addition to structuring and Shell Corporation, IRS is also looking for any kind of unusual deductions, clearly personal deductions that could give rise to extra scrutiny.

Steve Moskowitz:
Charitable, some of the things they’re looking for is, if you would have an unscrupulous charity, working with a taxpayer. So for example, somebody contributes a million dollars to a charity and then the charity gives them back 900. Those things happen and they’re looking for that. And then also, if you take a look … just looking at the news, sometimes there’s a question as, well, someplace has registered as a charity, but are they really a charity and what are they doing with the money? Are they really engaging in charitable purpose or is this charity just a front, a shell, really, for the benefit of the person who set it up? These are all the things that the government looks at as well.

Cliff Capdevielle:
And account switching just as in the case of the FBAR investigations. If you switch accounts, especially after you receive some notice from the IRS or some other federal agency, that is going to trigger additional scrutiny, especially if it’s related to businesses. That is one of the red flags that the IRS always [crosstalk]

Steve Moskowitz:
Surprisingly, it’s amazing how many taxpayers will do this, where if they want to not pay tax on all their income, commit that crime, they will place some of the funds in their personal account, then they only hand the business account to their tax return preparer and say, here you go, and think they fooled somebody. If you get audited, the first thing the auditor does is part of what’s called at the very beginning, what’s called the income probe, and in the income probe, the order wants to look at all your accounts, business and personal, and then they’ll ask you, well, what are these deposits here in this account? Also, at the beginning of the income probe, the government actually ask the question, do you report all of your deposits in one account? What is that account?

And then some other people using a foreign area and are more sophisticated, and again, the more sophisticated you are, the more the government’s going to punish you, is what some people were doing until the Florida area really got under control was suppose a business person would say, well, you know what, I’m going to sell you some widgets, but send the money to their bank account in some foreign country and think they can hide from the government there. That was done … The bottom line is, again, it all has the basic same principle where some business person is trying to hide something from the government and the government has all these devices to catch it. And if they catch you, there’s big punishments involved and that’s what we want to avoid. And if you’ve done something that you shouldn’t, there’s also a program, it’s been around for a long time in the IRS, it’s called the Voluntary Disclosure Program, and that’s where the taxpayer usually goes to the attorney, goes to the government says, hi, my client couldn’t sleep at night and he’s done some things wrong. He would like to correct that. He’d like to correct it civilly and he’d like to see that no criminal punishment, and you make a deal with the government, they actually have a non prosecution letter where they go ahead and agree, hey, you won’t be punished criminally, you just make a deal civilly.

But again, all of these programs depend on the taxpayer going to the government before the government comes to the taxpayer. So suppose, for example, you’ve received that audit letter and you said, well, I was just listening to this webinar and I found out about personal accounts or the foreign accounts or this or that, it’s too late then because you’ve been notified by the government. Now back to Cliff.

Cliff Capdevielle:
And you touched on this already Steve, but if your declared income doesn’t match your deposits, that is a red flag, and that comes up all the time during any IRS audit that they do what’s called a bank deposit analysis, and if you have deposits, they don’t report on your tax return, the IRS is going to ask why. So oftentimes, there’s perfectly legitimate reasons why you haven’t declared that as income, it could be a loan, loan repayment, something like that, that’s not taxable, but certainly that’s going to get scrutiny. So you want to document all that, especially [crosstalk]

Steve Moskowitz:
Something as simple as inheritance, which would be a large amount of money in your personal bank account, [crosstalk] what’s this? Relative died, you prove that, you’re fine.

Cliff Capdevielle:
So obviously, one of the major goals that we have in any kind of audit is to avoid penalties. So the IRS has all kinds of penalties. One of the most serious is the civil fraud penalty. So Steve, if somebody walks into your office and they received a proposed assessment of a civil fraud penalty, what do you tell them?

Steve Moskowitz:
We have some serious work to do here. And when we’re talking about fraud penalties, there’s two types: criminal and civil. Criminal, they can put you into federal penitentiary. Civil, you have to pay a penalty of 75% of the tax plus interest. So the first thing we want to take a look at is, has the government or is the government in the process of making a criminal fraud penalty case, because what you have to watch out for is, in the old days, the criminal case came first and then the government do the civil case.

Now, a lot of times the government’s doing both together, and you’re using one as information for the other and there’s all kinds of problems with that. So for example, the burden of proof on the government is much higher on a criminal case in the civil case. So if you have already suffered a criminal fraud penalty, then it’s much easier for the government come and say, well, the government is already approved a much higher standard in the criminal area, and they want to slim donkey here. On the other hand, in dealing with the civil fraud penalty, you don’t want to give the government reason to think that maybe they should also go after you criminally. Civil fraud is very serious and you want to avoid that. And again, it’s not magic. This is going to be a negotiation between your attorney and the government to see if the government is willing to settle without having this, and if they are, that’s terrific, if not, then you want to consider, well, is this something I want to take into the court or not, and that’s a very important decision between the attorney and the client.

Cliff Capdevielle:
So you’ve talked about this a little bit already, but standard proof of course is a tough burden for the government. They have to prove by clearing convention evidence that you had underpaid your tax. And that is different from the regular civil penalty standard. So if it’s a negligence or other non fraud issued, generally that burden is going to be on the taxpayer to prove it. So the fraud penalties are more difficult challenge for the government, but certainly, you want to make sure that you are properly represented if you’re [crosstalk]

Steve Moskowitz:
And there’s another big reason to want to beat a civil fraud penalty. And with a civil fraud penalty, that’s going to affect the statute limitations, because generally, suppose somebody did something they shouldn’t have 10 years ago, and they walk in the office, well, the first thing we ask the client is, what year because if the statute of limitations has closed, and the facts don’t matter, it’s too late. So suppose the government says, hey, some years ago, your client did ask, then you say, statue limitations is closed, you can’t get them, it’s too late, forget about it. But the problem is the general statute is a three year statute, if you’ve underreported your income by more than 25%, a six year statute, criminal is generally a six year statute with an exception where the government in rare cases can get longer if they show it’s one chain.

But the civil fraud penalty, civil fraud doesn’t have a statute of limitation. So if the government nails you on that, that’s an effective way for them to go back and open a year that otherwise would have been long closed. So again, with a lot of these things, it’s not just the … that’s why your lawyer has to be really familiar with this because 75%, in and of itself, is bad enough. But what you don’t want to have happen is find out that you gave in to that and then all of a sudden, the government says, hey, now that we know you’ve committed civil fraud, we’re going to go way back and open up all kinds of years, that should have remained closed. So watch out for that. There’s multiple reasons to fight this.

Cliff Capdevielle:
And so what does the government look for in putting together a fraud case? So some of the more common badges of fraud would be two sets of books. So this typically comes about after a raid or a subpoena, the government has a set of books that matches what’s on the tax return. And then they have another set of books and the taxpayer that shows unreported income, either cash or otherwise. Also, if a client is arrested for any other illegal activity, there is likely going to be some underreporting with regard to the income from that.

Deal in cash. Well, deal in cash is not illegal, it is becoming more unusual, some restaurants and other businesses still deal in cash, but a cash basis business is likely to receive more scrutiny.

Steve Moskowitz:
And another thing the government takes a look at is your request for credit mortgages, credit cards and loans, because what some taxpayers do is, how should I say, double dip in the wrong doing, where they underreport their income to the IRS and over report it to the bank. And what comes as a shock to a lot of taxpayers is the IRS also investigates certain financial frauds And we’ve had cases where clients have done that, and firsthand client says, hey, that’s between the client and the bank, what’s the IRS have to do with it? They investigate those type of things. And they do it for multiple reasons. One, it is a crime to lie to a bank. So that’s one thing. And the other thing is the government uses it to support their case of unreported income.

So suppose for example, you really made a million dollars profit, and on your tax return you report 200 and the bank you tell them you made 3 million. Besides prosecuting you on the crime of attempting to defraud the bank, the IRS says, well, on your loan here, you said you make 3 million so we’re going to tax you on the 3 million. And we’ve also seen the IRS argue cases inconsistently where they say, well, look, you’re getting prosecuted for lying to the bank, telling them you’re making 3 million when you’re only making 1 million, and that same attorney turns around and says, but on your tax return, we’re going to accept the 3 million that you lied to the bank about so you’ll tax on the 3 million. So there’s all kinds of ramifications here.

Cliff Capdevielle:
Yes, certainly you want to be careful there. Also, make sure that you keep adequate records and failure to file returns, even though of itself is not proof of fraud, it is what’s called a badge of fraud and as part of an investigation, the IRS may argue that your failure to file returns was intentional, and therefore fraudulent. So, Steve, you want to talk about how important it is that you keep current on your filing?

Steve Moskowitz:
Yes, I do. And it is amazing how common it is people that don’t file tax returns. And I’m talking people from all walks of life, just like medical problems. It doesn’t matter whether you’re a brain surgeon or unemployed. You can still have the same medical problems. It’s amazing how common failure to file is. The number one reason we find people don’t file a return is simply people don’t have the money to pay. They make the mistake of not filing. And then once they make the first mistake, then year two comes around, and they say, well, how can they file year two and they didn’t file year one, and then year three comes around, and all of a sudden becomes a lifestyle, a criminal like lifestyle, and people are looking over their shoulders. I personally have seen people ruin their lives over this. Businesses are destroyed that didn’t have to be. Marriages are destroyed. I’ve seen two husbands commit suicide over this, I saw a man give up his son for adoption because of that, and just tragedies, tragedies, tragedies that just don’t have to be, and the bottom line is, whatever the reason you haven’t filed the return, the most common being just you didn’t have the money, that’s okay. We can make a deal for you and you can have a normal life and then sleep innocent, not go ahead and do these type of illegal things.

Other things that I recommend, which is different than the rulebook, where if you look in the IRS instruction booklet, it’ll tell you, well, how long do I have to keep my returns? It’ll tell you generally for the period of time, for the statute limitations. People ask me, how long should I keep my records? I always have the same answer forever, because I’ve done cases, two recent cases come to mind, where they’re both widows, the agent said to the widow, hey, you didn’t file the tax return for your so and so. And so she’s [inaudible] I don’t know anything about that. And the bottom line is, if you don’t have the records, the government says, well, you don’t have the records, you didn’t do it. Pay the taxes, but now, not only paying taxes, and you paying penalties, and the penalties are stiff, the failure to file penalty is 25% of the tax, plus interest you go back all those years, there’s a problem.

And again, you say, well, wait a minute, weren’t you guys talking about statute limitations a minute ago? Yes, we were. But that three year statute that we mentioned, it’s three years from the time you filed the return. So the problem is on the civil side, if you haven’t filed the return, the statute may have never run, and I’ve seen the government go way back. So the bottom line is, you want to go ahead and file the returns.

And sometimes people will say, well, what about if you don’t have any income, somebody’s supporting you? I still like to go ahead and file with a zero on it because you start the running of the statute limitations, but that gets into other areas besides this so I’ll take it back to Cliff. [crosstalk]

Liz Prehn:
Okay, I’m sorry. Question, some people are receiving notices from the IRS offering them the opportunity to amend their tax return to report their cryptocurrency. What does this mean and what do you recommend?

Steve Moskowitz:
Well, number one, I definitely pay attention to it, and then what I would do is see is an amendment needed. Now in the legal circles, there is a difference of opinion, whether sometimes somebody should amend something or not. Some attorneys say, well, if you go ahead and amend, that’s an admission of wrongdoing. Other attorneys say, well, wait a minute, is a practical matter. If you were to amend, that takes an awful lot incentive away from the government to recommend a criminal prosecution against you. So this isn’t a right or wrong or the tax return’s due April 15. This is a considered decision and the bottom line … and there’s different rules, but the bottom line is that first, the taxpayer and the attorney should go over, is the IRS letter right or wrong because oftentimes the letters are wrong. And maybe instead of amending, an explanation to the government is, well, no, my original return was right and here’s why. On the other hand, if you did something that maybe you shouldn’t have, amending the return as a practical matter, might head off all kinds of problems, criminal and civil, they could come about. So the bottom line is that’s on a case by case basis and you go ahead and you want to do … certainly comply with all laws, and do what’s best here. But that’s really important.

Cliff Capdevielle:
Yes, the IRS actually used to have a formal policy against prosecuting anybody who found amending a return before a criminal investigation was started. That’s not the formal policy of the IRS anymore, but in fact, it is very rare that we see anybody, criminally prosecuted who gets their amended return filed before the IRS gets to them. That’s why it’s so important. Go ahead.

Steve Moskowitz:
And that’s why I so often, and again, I’m not offering any specific advice in this webinar, that’s individual. But in practice, that’s why so often, I recommend filing the amended return, because as a practical matter, like I was just saying, the reason the government doesn’t want to prosecute you, if you amend and they prosecute you anyway, then people say, well, what incentive do they have to come forward and fix things if they’re going to be punished for it? As a practical matter, a lot of times, amending the return, effectively fixes the problems and you all know before I was a tax attorney, I was a CPA. So many times, that fixes the problem, so many times we recommend that, and so many times, regardless of formal policy, the IRS says, well, you fix the problem, and you leave it there, and then you have an argument against even civil penalties, much less than heavy duty criminal stuff.

Cliff Capdevielle:
And obviously, fraud is not negligence, if it’s an honest mistake, that’s not fraud. So we talked about this a little bit, but certainly, the more of these badges of fraud that you have in your case, the more likely you are to be prosecuted. So how do you respond if the IRS sent you a CP 2000. You can’t pay the entire amount. We can help you with that, if you need a payment plan, or if you disagree with the amount of the proposed, we can certainly help. [crosstalk]

Liz Prehn:
And let’s just take a second there. So many times, the IRS will send a very official looking letter demanding and amount of money. And so many times the taxpayer owes something, but not nearly what the government says because, for example, if you don’t do returns, the government does an SFR, substitute for return, they prepare something to be totally wrong. For example, like with crypto, they say, aha, they caught you on sales and they tax you on the gross revenue from the sales. Hey, wait a minute, wait a minute. I had all kinds of costs to go with this, you’re only supposed to tax me on the net. That’s a major area where even if you get one of these bills, we can greatly reduce it in the crypto area or other areas. And if you truly owe the money and you can’t pay it, you may qualify for an offer and compromise where you just pay part and the government wipes clean the rest of the slate, all kinds of stuff. But again, like a medical problem, whatever you do, don’t ignore it. It only gets worse if you ignore it.

Cliff Capdevielle:
So what’s going on with the crypto notices? Many people have received these letters 6173 or 6174. Most typically, it’s because the government has some information about some crypto in some wallet, most likely Coinbase, but it could be other exchanges. You’ve got to respond to that. And Coinbase is cooperating with the summon, so certainly, they’re going to have the information. If you’re using one of the exchanges, and they have received the summons from the IRS, you will almost certainly receive one of those letters. So what do you do? You got to track these … the exchanges are getting better about tracking this information for you, so that you don’t have to do this, but if you’re using some exchange that is not tracking the basis, you’ve got to track that basis and the fair market value of each unit at each transaction, whether you’re buying or selling, you’ve got to track the value of that coin in every transaction.

What happens if you get audited? Well, Steve’s going to tell you that you got to respond. You don’t want to hide your head in the sand. You’ve got to respond to the notification of the exam and be prepared to respond to all the document requests of the auditor, typically, it’s a year to 18 months, before you’re all done, and if you’ve been careful about tracking your records, that can mean a no change audit, if you haven’t been so careful, you may have to do a bit of accounting and that that can add some additional time to the audit process-

Steve Moskowitz:
But also to decrease your stress in almost all cases, your attorney can do everything for you and you don’t have to talk to the IRS, deal with them, having to deal with them. That greatly reduces your stress.

Cliff Capdevielle:
Right. So what is the IRS looking for in these information, document requests? It’s going to be obviously all the transaction information. It’s going to be correspondence, emails, texts, between you and the exchange. But if you’ve purchased or sold off an exchange, or you purchased other property with virtual currency, you’re going to have to track all of that in and the IRS is going to ask for all of your documents, correspondence, emails with regard to any of those transactions.

Steve Moskowitz:
And also watch out here because this IDR is information document request, oftentimes you get multiple ones. You provide the information, the IRS says, well, that’s interesting. Now I want to know about this, much like pulling sugar plums, one question turns into two, two four and so on. However, that’s also important for your attorney to object to once for example, if they’ve asked for something, they’re not entitled to. [inaudible] is passed or just information, that’s a fishing trip or just information that they’re not entitled to. The lawyer will say, well, wait a minute, you’re not entitled to this information, we’re not going to provide it and here’s why. It’s not open ended either from the IRS point of view. And you have to be careful there because some auditors will ask for all kinds of information to which they’re not legally entitled.

Cliff Capdevielle:
Sometimes the audit doesn’t end at the field level. In other words, you’re not able to come to a complete agreement with the auditor, in your case, you can ask for an appeal and we do this often. The goal of appeal is somewhat different than the office auditor, the field auditor, who are going for the maximum assessment, the appeal’s officer is charged with resolving the issues. So oftentimes, the IRS wants to stay at a court and we get very good results in appeals. Sometimes clients try to represent themselves to the audit, they’re not successful. They come to us and we get a better result through the appeal’s office. [crosstalk]

Steve Moskowitz:
And let’s talk about how we get to appeals which is really important. There’s two ways to go. Accountants just go directly from the audit to the appeals, so that’s all they [inaudible] and do. And as attorneys, we normally will file a tax court petition first, the clerk of the Tax Court will automatically send it back to appeals, the same exact place. So why are we taking a circuitous path? There’s two reasons. One, if we’ve already docketed the Tax Court case, that changes the burden of proof from the taxpayer to the government for any new issues raised by the government. Remember, the appeals’ officer is usually far more experienced than the auditor. And you may have a problem with the return, that the auditor just didn’t see, but the appeals officer would. If you dock at the Tax Court first, you’ve changed the burden of proof and now the appeals officer has to prove that you’re not entitled to it, and the bottom line is for most of the time, they won’t bother because they don’t have the time, they don’t have the information.

Secondly, is statistical. If you look at statistics, the settlements and that means is, how much did the appeals officer give you. are much, much much better for cases that are docketed with the Tax Court than the ones that aren’t, because what the accountants, the appeals is really the last stop, they can’t go any further and that’s it. But with the tax lawyer like us, we actually have to do something to prevent the case from automatically, if there’s a period of time, going from the appeals officer to the Tax Court. Bottom line is if you just look statistically, you have a much better chance of getting a much better settlement if you’ve docketed in Tax Court. Now, onto the Tax Court.

Cliff Capdevielle:
Okay. So Steve, I was asking, is there ever a time where you’re going to file a case in the quarter claims or district court instead of in the Tax Court?

Steve Moskowitz:
Absolutely. And usually, when you ask, is there ever, almost always the answer is yes. Yes. And there’s multiple reasons why. We actually check the precedent of all three courts, and we might find a precedent was greater for the taxpayer in one court [inaudible] so we’d file there. And also, do we want a jury in the federal district court, we can ask for a jury. And we may have an issue that a jury would like better than just going before the judge. So the bottom line is, again, when you go to the tax lawyer, there’s a lot of things that are considered just like going to a medical doctor, if you have a problem. Does he or she give you a pill or surgery or recommend you change something in your life? The bottom line is that’s part of what experience does. You say, well, wait a minute, in your case, you want to do something differently than what most other cases would do. That’s something that’s so, so valuable with an experienced tax attorney.

Cliff Capdevielle:
And how else can Moskowitz help, Steve, if a client gets a notice, if they’re in audit? What can you do for a client to help [crosstalk]

Steve Moskowitz:
There’s a law. We’re not just dusting off some old dusty law books and say, regulation 123 requires that you. We are business people, we’re practical, we deal with business people all the time. We will want to work out a practical solution that will work for you and is acceptable to the government. And everybody is different, just like that physician examining will say, what are you doing here? And we’ll take a look at exposures. Do you have a criminal exposure? Do you have a civil fraud penalty exposure? Do we have unfiled returns? How are your receipts? Do we need witnesses? Do we have them? And we go over a host of things And then we tell her something, what works best for this client, and there’s all types of things, and then after we get them out of trouble, most of those people stay with us, where we do tax planning. There’s so many times in my career, I’ve said to a client, well, we’re really happy, we got you out of trouble. Now, let’s show you how to legally save taxes, and the irony is we can save you more legally, than you go ahead and you’re doing on your own and risking going to prison. And if you take a look at that, think about it.

If somebody right now is a minimum wage worker, you know they’re paying more taxes than Apple Computer? Well, how is that possible? Because there’s tax attorneys working with Apple to say, do this and this and this and this, to not pay taxes. Look at the Fortune 500. How often do those companies make profits, profits in the billions with a B, yet they legally don’t pay any taxes? Every year, you see that in the newspaper. All these things we do with our clients too. And much smaller companies than Fortune 500s, the principles are still the same. There’s so many different things you can do with tax planning to save money and legally do that. And people would say, well, how can that be possibly you make all this profit and not pay taxes? Because what people forget about is there’s two purposes to the tax system.

Everybody knows about one, getting money out of us. But the other one is, in a democracy, even though the government would like us to do certain things because it’s good for the economy, they can’t order you to do it. So how does the government get you to do something they want you to do, but they can’t order you to do? How’s that work? They give you tax incentives. And that’s what all the big companies do and that’s what we do for our clients a lot. Hey, look, in a case like yours, if you just made this change here, you can legally avoid these taxes. In my whole career, when I have counseled is people take such horrible risks to save taxes, do things illegally, you never, never, never want to do anything illegally. When oftentimes, legally, you can save more taxes, but people just don’t know about these other tax saving areas. And those are all things that if we get them out of trouble, we talk to them about. Obviously, if you’re not in trouble, we start off-

Cliff Capdevielle:
Thank you, Steve and thank you Cliff.

Steve Moskowitz:
Thank you Cliff. Thank you Liz.

Liz Prehn:
Thank you everyone. Feel free to reach out to us directly with your questions or comments, and we will get back to you shortly. Thank you, everyone. Bye, bye.