Bitcoin Offshore Abusive Tax scheme is now at the center of the new war against offshore tax noncompliance. The IRS started this war on November 17, 2016, with the John Doe Summons petition against Coinbase, Inc., the largest US bitcoin exchanger. In this petition, the IRS Revenue Agent David Utzke details one variation of the Bitcoin Offshore Abusive Tax scheme that seems to be the main target of the IRS battle against Coinbase. Let’s discuss it in more detail.
Traditional Offshore Abusive Tax Scheme
In the petition, the IRS first provided a description of a common traditional offshore abusive tax scheme based on a real-life example of “Taxpayer 1″. In this scheme, Taxpayer 1 retained the services of a foreign promoter who set up a controlled foreign corporation which was merely a shell corporation. The corporation first diverted the taxpayer’s income to a foreign brokerage account and, then, to a foreign bank account. After the funds were transferred to a foreign bank account, Taxpayer 1 was able to repatriate the funds as cash (US dollars) through an ATM machine.
Obviously, this scheme had a number of disadvantages. First, it was not cheap: Taxpayer 1 had to retain foreign attorneys and engage in various other regulatory expenses.
Second and most importantly, the entire scheme was done in US dollars and, hence, ran a relatively high risk of the IRS detection. If the IRS discovered the scheme, it would not be difficult to trace it directly to Taxpayer 1. The weakest point of the scheme was the repatriation in US dollars of the hidden income.
Bitcoin Offshore Abusive Tax Scheme
When Taxpayer 1 discovered bitcoins, he adopted a new model which I will call a Bitcoin Offshore Abusive Tax Scheme. The first two steps (i.e. the diversion of income) were the same – a controlled foreign shell corporation was set up and the funds were diverted to a foreign account.
The difference between the schemes was really in the repatriation process. Under the Bitcoin Offshore Abusive Tax Scheme, the funds from a foreign account were moved to a bank which worked with a virtual currency exchanger (such as Coinbase), converted to bitcoins and placed in a virtual currency account. Then, the taxpayer used the bitcoins to anonymously purchase goods and services without ever converting the hidden income into US dollars. Under this process, Taxpayer 1 had hoped to avoid the IRS detection of the repatriation of funds.
Bitcoin Offshore Abusive Tax Scheme Protects the Taxpayer From IRS Detection During the Repatriation Process
The biggest advantage of the Bitcoin Offshore Abusive Tax Scheme is its ability to protect a taxpayer from the IRS detection when he tries to repatriate the undisclosed income back to the United States. Since bitcoin ownership and purchases are done anonymously and without conversion to US dollars, the IRS may never be able to detect tax noncompliance.
Revenue Agent Utzke himself states in the petition that “because there is no third-party reporting of virtual currency transactions for tax purposes, the risk/reward ratio for a taxpayer in the virtual currency environment is extremely low, and the likelihood of underreporting is significant”.
Indeed, it appears that Taxpayer 1 was highly successful in his Bitcoin Offshore Abusive Tax Scheme. The discovery of that scheme was only made possible due to the voluntary disclosure of Taxpayer 1 to the IRS (most likely Taxpayer 1 prudently decided to enter the OVDP).
Bitcoin Offshore Abusive Tax Scheme Begins to Dominate Offshore Tax Noncompliance
These advantages of the Bitcoin Offshore Abusive Tax Scheme led to its increasing popularity among noncompliant US taxpayers. In fact, it appears that the Bitcoin Offshore Abusive Tax Scheme now dominates this market. Even Agent Utzke admitted that virtual currencies have now largely replaced “traditional abusive tax arrangements as the preferred method for tax evaders”. The John Doe Summons Against Coinbase is Aimed at the Bitcoin Offshore Abusive Tax Scheme.
Given this fact, it is little surprise that the IRS decided to begin a war against abusive tax schemes involving virtual currencies and, especially, bitcoins. The John Doe Summons Petition against Coinbase is the first battle of this war against the Bitcoin Offshore Abusive Tax Scheme.
Given the IRS victory in its battle against Swiss banks, it is very likely that, in one form or another, the IRS will prevail against Coinbase and the virtual currency industry in general. This victory will result in the exposure of noncompliant US taxpayers who will then face a litany of draconian IRS penalties, including possibly criminal penalties and jail time.
Noncompliant US Taxpayer Engaged in a Bitcoin Offshore Abusive Tax Scheme Should Consider Voluntary Disclosure
Given this precarious legal environment and the significant risk of the IRS detection, noncompliant US taxpayers should consider doing a voluntary disclosure while they have the ability to do so. Once the IRS identifies noncompliant taxpayers and commences investigations against them, these taxpayers may lose forever the ability to do a voluntary disclosure to avoid criminal penalties and reduce civil penalties.
This is why these taxpayers urgently need to contact an international tax lawyer to consider their voluntary disclosure options.
Contact Sherayzen Law Office for Legal Help with Bitcoin Tax Noncompliance
If you are a US taxpayer who has engaged in a Bitcoin Offshore Abusive Tax Scheme or any other tax noncompliance involving bitcoins, contact Sherayzen Law Office for professional help as soon as possible. Our legal and accounting team has helped hundreds of US taxpayers with their voluntary disclosures and we can help You!