GAO: IRS needs to keep an eye on virtual currencies

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With the explosion of online activity in recent years, lawmakers are becoming increasingly concerned about how those actions, sometimes taking place in economies that exist entirely within a specific program, might impair the abilities of the IRS to collect what's due.

The report was done at the behest of the Senate Finance Committee, which asked GAO to review virtual economies and the currencies they use for any potential tax issues and how the IRS might address them.

The GAO identified a host of virtual currencies, what purpose they serve in their respective economies and the tax implications of each arrangement. For example, some "closed-flow" currencies do not come with a tax issue, because the virtual currency exists entirely within a virtual setting and cannot be used to obtain real goods and services or turned into U.S. dollars.

By contrast, mixed and open systems could carry tax implications, as users are able to turn a virtual currency or good into something with real-world value, or even U.S. dollars.

As an example, the virtual world "Second Life" allows users to buy and sell virtual assets with "Linden dollars," and that virtual currency can be exchanged for hard currency using third-party payment networks.

And bitcoin users can use that virtual currency to engage in real economic activity, which could carry tax implications.

All that means the IRS could be facing major challenges in ensuring that users of virtual currencies are meeting their real world tax obligations.

The GAO said taxpayers might not realize they have a tax liability tied to their virtual activity, or might be aware of the obligation but unsure how to characterize or calculate it for tax purposes.

Information reporting from third parties was also found by GAO to be scarce, which added that virtual currencies might offer a way to hide taxable income from the U.S., because transactions are difficult to trace and some virtual economies come with a level of anonymity as well.

The GAO noted that the IRS has done some work on this matter, researching virtual currencies and the tax challenges they could pose. Given the rapidly changing subject area, as well as the fact that virtual currencies do not appear to be a major tax compliance threat yet, the IRS has not adopted a comprehensive framework for compliance on the matter, or published specific guidance.

Rather it's taking a more informal approach — posting information on its website about the tax implications of virtual activity. IRS officials told the GAO it opted for this approach because it was more cost-effective.