Crypto Still Not Foreign

U.S. tax law has special provisions for transactions in foreign currencies. Nine years ago, when crypto was in its infancy, the IRS stated that foreign currency rules would not apply to cryptocurrencies. Instead, crypto would simply be treated as property.

In making that ruling, the IRS observed that virtual currency did not have the status of legal tender in any jurisdiction. Since then, however, two countries, El Salvador and Central African Republic, have adopted bitcoin as legal tender.

Some taxpayers may have wished to exploit this development by applying the foreign currency rules to bitcoin transactions. The IRS has now published Notice 2023-34, clarifying that although bitcoin has been adopted as legal tender in some countries, virtual currencies will continue to be treated as property, not currency, for U.S. federal tax purposes. The special rules for foreign currency transactions will not apply.

From Fraud to Failure

A recent tax case involved a psychiatrist who had been charged with healthcare fraud. His plea deal required him to make some $2 million in reimbursements to Medicare and other insurers. Seeking to ease the pain, he filed for an income tax refund of over $800,000. He argued that he should be allowed to recover the tax he paid on the $2 million he didn’t get to keep.

He was hoping to recover under a section of the Internal Revenue Code dealing with a concept called claim of right. This rule may apply in a situation where you paid tax on an item of income in an earlier year, believing you had a right to that income, but later had to repay the money. The rule can prevent unfairness in a situation where you pay tax on income you don’t get to keep.

The dishonest doctor had a problem, though. One of the requirements of this rule is that you had an unrestricted right to the income in the year you paid the tax. The court observed that this taxpayer never had a right to this money at all, as he obtained it through fraud. Refund denied.

The poor guy paid tax on the money, didn’t get to keep it, and couldn’t recover the tax. We could almost feel sorry for him if it weren’t for that detail about how he got into this mess.

Stumbling Start to Tax Season

The 2023 tax season kicked off January 23. Eleven days later, the IRS suggested that many taxpayer hold off on filing while they prepared guidance on a unique problem affecting millions of taxpayers. In 2022, many states responded to the pandemic by sending their residents special tax refunds or other payments. Were recipients of these payments required to report them as income on their federal income tax returns? Fortunately, most were not.

details: 2022 State Pandemic Payments