IRS Steps Up Cryptocurrency Tax Enforcement Efforts

IRS Steps Up Cryptocurrency Tax Enforcement Efforts

By Marcus E. Dyer, CPA, Esq., Withum – July 20, 2020

When the first versions of cryptocurrency were formulated back in the 1980s, scant evidence of concern could be found from the government. In 2017, after the Treasury Inspector General for Tax Administration criticized the IRS for failing to develop a coordinated virtual currency strategy, the IRS announced concern over “massive” underreporting of income generated by cryptocurrencies.

Today, a question appears at the top of Schedule 1 of Form 1040 inquiring if the taxpayer engaged in any virtual currency transactions during the year. This article ad­dresses the current efforts the IRS is making to stay ahead of the cryptocurrency curve and promote compliance with income tax laws applicable to virtual currency. 

How is Cryptocurrency Taxed?  

The IRS explains the taxation of cryptocurrency in Notice 2014-21. It says virtual currency is treated as property, not as currency, for U.S. federal tax purposes. Generally, this means payments made using virtual currency to independent contractors are taxable, and self-employment tax rules generally apply. Wages paid to employees using virtual currency are taxable to the employee and must be reported by an employer on a Form W-2. Transactions involving an exchange between cryptocurrency and other property are taxable as gains or losses. 

What Cryptocurrency Enforcement Challenges Exist?

In recently published guidance, the IRS addresses some of the common misunder­standings taxpayers have with respect to the taxation of cryptocurrency transactions. Common areas of confusion exist with re­spect to “coin-to-coin” exchanges, hard fork transactions and the determination of basis.

  • Currency-to-currency exchanges. Some taxpayers mistakenly believe coin-to-coin trades, such as Bitcoin for Ethereum cryptocurrency, is a nontaxable exchange of essentially the same kind of currency. According to the IRS, currency exchanges are subject to the same capital gains and loss rules of prop­erty exchanges generally.
  • Hard forks (chain splits). Taxpayer uncertainty abounds on a common cryptocurrency transaction called a hard fork. A hard fork occurs when cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. Surprisingly, the IRS didn’t provide comprehensive guidance on this topic until 2019 in Rev. Proc. 2019-24.
  • Tracking basis. According to the IRS, tracking basis is essential for reporting crypto transactions accurately. Yet, the IRS suspects some virtual currency users have gone years without keeping track of basis out of confusion about its relevance or sheer negligence.

How the IRS Is Enforcing the Law

The IRS has developed a multi-prong approach to prevent the evasion of tax laws applicable to cryptocurrency. Elements of the strategy include data analytics, tax examinations, soft letters and criminal charges. 

  • Soft letters. In 2019, the IRS sent letters to more than 10,000 holders of cryptocurrency warning that audits and other enforcement actions may result if the taxpayer failed to report income from virtual currency transactions and corrective actions are not taken.
  • Data analytics. Since 2015, the IRS has contracted with Chainalysis, a company that provides data and analysis services to help the government identify cryptocurrency users with unreported income.
  • Tax examinations. In 2018, the IRS announced a Virtual Currency Compliance Campaign. Through this program, the IRS is conducting exhaustive issue-based examinations of tax returns designed to address noncompliance related to the use of virtual currency.
  • Criminal prosecutions. In extreme cases, taxpayers may be subject to criminal prosecution for failing to properly report income from virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return.

IRS Criminal Investigation reported in its Fiscal Year 2019 Annual Report that a key focus for the organization is cybercrimes, with an emphasis on cryptocurrencies.

Taxpayers who have traded or received cryptocurrency should make sure they have reported their income properly given the IRS’s increasing interest in virtual currency. 

Please contact us if you have any questions pertaining to your specific circumstances.

IRS Steps Up Cryptocurrency Tax Enforcement Efforts

Corporate Income Tax Rates – 2019

Corporate Income Tax Rates – 2019

The federal general (and M & P) corporate income tax rate remains 15 percent. Provincial and territorial general (and M & P) rates remained mostly steady but decreased in Alberta and Quebec for December 31, 2019 year-ends. The general (and M & P) rate in Alberta decreased from 12 percent to 11 percent after June 2019 and will continue to decrease, to 10 percent after 2019, 9 percent after 2020, and 8 percent after 2021. Quebec’s general (and M & P) rate decreased from 11.7 percent to 11.6 percent after 2018 and will further decrease to 11.5 percent after 2019. The table below shows the 2018 and 2019 combined general, M & P, and small business rates.

The federal small business tax rate decreased from 10 percent to 9 percent after 2018; as a result, all combined federal and provincial/ territorial small business rates decreased in 2019. In addition, for December 31, 2019 year-ends, provincial and territorial small business rates decreased in New Brunswick, Nunavut, and Prince Edward Island (and in Quebec for the non-M & P small business rate only). The provincial/territorial small business rate in New Brunswick decreased from 3 percent to 2.5 percent after March 2018, and in Nunavut from 4 percent to 3 percent after June 2019. In Prince Edward Island, the small business rate decreased from 4 percent to 3.5 percent after 2018; and will further decrease to 3 percent after 2019. Quebec’s non-M & P small business tax rate decreased from 8 percent to 7 percent after March 27, 2018, and to 6 percent after 2018, and will further decrease to n5 percent after 2019, and to 4 percent after 2020. Small business thresholds remain unchanged in 2019 except in Manitoba, where the province’s small business threshold increased from $450,000 to $500,000, effective after 2018.

Corporate tax rate table containing Federal and provincial tax rates for 2018 and 2019

Please contact us if you have any questions.

2018 Budget Simplifies Passive Investment Rules

2018 Budget Simplifies Passive Investment Rule

The 2018 federal budget introduced measures to simplify the new taxation regime for passive investments held inside a private corporation. These changes bring some long-anticipated clarity to a significant aspect of Finance’s recent private corporation tax proposals. The new rules provide that the amount of income eligible for the small business tax rate will be reduced depending on the amount of investment income held. In addition, the budget proposes new rules for CCPCs to access refundable taxes on the distribution of certain dividends. The rules, which also include certain anti-avoidance measures, will apply for taxation years beginning after 2018.

In July 2017, Finance released a consultation paper and proposed rules to address certain tax planning involving private corporations, including income sprinkling using private corporations, the conversion of a private corporation’s income into capital gains, and the accumulation of surplus savings and other passive investments in a private corporation. In October 2017, Finance announced that it was abandoning its capital gains measures and that there would be no tax increase on passive investment income below a $50,000 annual threshold. At that time, Finance indicated that it would provide additional details on the passive investment regime in its 2018 federal budget.

Finance also indicated that it intends to proceed with its tax measures, released on December 13, 2017, to address income sprinkling. These rules will likely be included in one of the budget implementation bills.

The federal budget’s passive investment income rules propose to reduce the small business limit for CCPCs (and associated corporations) that have a certain threshold of income from passive investments. The limit applies on a straightline basis for CCPCs that have between $50,000 and $150,000 of investment income. The budget also reduces the small business deduction by $5 for every $1 of investment income above the $50,000 threshold, so that the business limit would be eliminated for investment income of more than $150,000. As a result, a corporation’s access to the small business deduction could now be restricted or eliminated entirely if the corporation
(or a corporation within the associated group) earns passive investment income in excess of $50,000.

The new business limit reduction will operate in tandem with the existing business limit reduction for taxable capital. Currently, the existing rules reduce the business limit for taxable capital between $10 million and $15 million employed in Canada of the corporation and associated corporations. The reduction in a corporation’s business limit will be the greater of the reduction under the new measures and the reduction under the existing taxable reduction provisions.

To determine a corporation’s investment income, the budget proposes a new concept, “adjusted aggregate investment income” (AAII). Generally, aa ii will include dividends from non-connected corporations and income from savings in a life insurance policy that is not an exempt policy but will exclude taxable capital gains (and allowable capital losses) from the sale of active investments and investment income that is incidental to the business. It appears that these exclusions are intended to continue to encourage venture capitalists and angel investors to foster Canadian innovation.

The budget also proposes to limit certain tax advantages that CCPCs can use to access refundable taxes on the distribution of certain dividends. Specifically, the proposals allow a refund of RDTOH only when a private corporation pays noneligible dividends; currently, a corporation can receive the refund upon the payment of an eligible dividend. The budget also proposes an exception for RDTOH that arises when a corporation receives eligible portfolio dividends. The corporation will still be able to obtain a refund of that RDTOH upon the payment of eligible dividends.

To address the refund of taxes associated with portfolio dividends, the budget proposes to introduce a two- RDTOH pool system under which a new “eligible RDTOH ” account will track refundable taxes paid under part iv of the Act, while the current RDTOH account, now redefined as “non-eligible
RDTOH,” will track refundable taxes paid under part I and part IV (on non-eligible portfolio dividends). A taxpayer will be able to obtain refunds from its non-eligible RDTOH account only upon the payment of non-eligible dividends. When a private corporation pays non-eligible dividends, the corporate dividend refund must come out of its non-eligible RDTOH account before it comes out of its eligible RDTOH account.

The budget also includes specific transitional rules for existing RDTOH balances. Generally, these rules state that a CCPC’s opening eligible RDTOH account will be the lesser of its existing RDTOH balance and 38.33 percent of its grip. Any remaining RDTOH balance for the CCPC will be added to the opening non-eligible RDTOH account balance. For all other private corporations, the existing RDTOH balance will be added to the opening eligible RDTOH account.

As a result of these changes, corporations will no longer be able to recover RDTOH through the payment of an eligible dividend, which resulted in a lower tax rate than Finance intended to apply. To recover RDTOH, the corporation may first be required to pay non-eligible dividends, which are generally taxed at higher rates than eligible dividends (for example, approximately 9.5 percent higher at the highest marginal tax rate in British Columbia in 2018)

Contact us to help you optimize corporate taxes when earning investment income.

Should you incorporate? Read on to find the answer.

Should you incorporate? Read on to find the answer.

To incorporate or not to incorporate? The answer really depends on your particular situation, but we will cover some of the main pros and cons so you can make a decision.

Limited Liability

One of the main advantages of incorporation is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the business that is being carried on when a business becomes incorporated, an individual shareholder’s liability is limited to the amount he or she has invested in the company.

As a sole proprietor, your personal assets could be on the line if there’s a legal claim against you by one of your customers, employees or contractors.

Taxes and Deferrals

If you are incorporated, you have more freedom to determine how much and how to get compensated for your efforts and contributions. You can get paid via salary or dividends and also leave the excess earnings in the corporation allowing for tax deferral. If you own Canadian-controlled private corporations or CCPC, the corporate earnings are subject to a beneficial corporate tax rate. Also, the first ~$30,000 of dividends generally, do not bear any personal level of taxation.


Generally, during the initial years, you may incur losses. If the business is incorporated, the losses would remain in the corporation and would be applied against future income.  As a sole proprietor, business losses would be deductible against all types of income.  Depending on your personal situation, carefully examine whether you want business losses to reduce your personal income tax or remain in your business, and time your incorporation accordingly.

Selling your business

It is easier to sell an incorporated business rather than a sole proprietorship. You may also be able to take advantage of the lifetime capital gains exemption if you sell shares of your business. On the disposition of a qualified small business corporation shares, the exemption is up to a lifetime limit of ~$800,000 of capital gains.

Incorporation comes with some disadvantages.  The setup costs in Canada could be as much as $2,000 (including legal fees) and you would also be required to file taxes annually, however, in many cases, the benefits of incorporation outweigh the administrative and set up costs. Contact us today to find out if incorporating your business makes sense for you.

Exceptions to the US Residency Substantial Presence Test?

Exceptions to the US Residency Substantial Presence Test

You will be considered a United States (US) resident for tax purposes if you meet the substantial presence test for the calendar year. This test boils down to counting your days in the US. You can also be considered a US resident if you have a lawful permanent residence (a green card) in the United States.

To meet the substantial presence test, you must be physically present in the US on at least:

1. 31 days during the current year, and

2. 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:

  • All the days you were present in the current year, and
  • 1/3 of the days you were present in the first year before the current year, and
  • 1/6 of the days you were present in the second year before the current year.

However, there are certain exceptions to this “presence” rule, including:

  • days you commute to work in the US from a residence in Canada if you regularly commute from Canada;
  • days you are in the US for less than 24 hours when you are in transit between two places outside the United States;
  • days you are in the US as a crew member of a foreign vessel; and
  • days you are unable to leave the US because of a medical condition that develops while you are there.

Also, there are also several categories of exempt individuals, which include:

  • an individual temporarily present in the US under certain foreign-government-related visas;
  • a teacher or trainee temporarily present in the US under a J or Q visa
  • a student temporarily present in the US under an F, J, M, or Q visa; and
  • a professional athlete temporarily in the US to compete in a charitable sporting event.

In general, these individuals can exclude days in the US for the purposes of the substantial presence test. To do, an individual would need to file IRS form 8843.

Even if you do not qualify for one of the exceptions noted above, you may still be treated as a non-US resident if you can meet the closer connection exception or if you qualify as a resident of another country under an income tax treaty. The more common exception is to have a closer connection to a foreign country, which is determined on the basis of an individual’s circumstances. Form 8840 must be filed with the IRS to claim this exception.

Given that US residents are required to file annual US income tax returns and report their worldwide income, Canadian individuals should be aware of the US residency rules, especially if they are spending significant time across the border. Those spending time in the US should consider whether they qualify for an exception to the substantial presence test, such as the closer connection exception.

Please contact us if you have any questions pertaining to your specific circumstances.

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