The IRS has long maintained a Voluntary Disclosure Program (VDP), which allows taxpayers who willfully omit certain information from their tax returns to get back in “good standing” with the IRS. Recently, crypto¹ was added to this program through changes to the VDP application instructions.² As with most everything, there are good aspects and bad aspects to this.

Bad Aspects of Crypto’s Addition to the VDP

Although the IRS has been focused on crypto enforcement in the past, the addition of crypto to the VDP application instructions can be seen as a warning to taxpayers that serious IRS action may be imminent for crypto transactions. The expanded application is a sign that the IRS might aggressively pursue taxpayer non-compliance in this area. It is also a final call to taxpayers to come into compliance quickly, or risk criminal prosecution because eligibility to participate in the VDP evaporates once a taxpayer is either audited or investigated by the IRS. Increased IRS audits and prosecutions in this area are almost certain, and there will likely be little sympathy for taxpayers that willfully fail to report their crypto holdings and gains.

Good Aspects of Crypto’s Addition to the VDP

Although entering the VDP is no guarantee against prosecution, it is certainly a step in the right direction. While the VDP process is not pleasant, it may be the best avenue for many taxpayers to “come in from the cold” to try to avoid more serious penalties and criminal liability. We note that although foreign accounts holding only crypto assets are not currently subject to FBAR reporting, FinCEN in its Notice 2020-2 proposes amending the FBAR regulations to include virtual currency accounts as a type of reportable account.

The Basics of the VDP Process

The VDP involves a long process that should not be entered into lightly. First, the following information must be reported to the IRS:

• Information for all non-compliant virtual currency the taxpayer owned, controlled or was the beneficial owner of, either directly or indirectly, for the entire disclosure period of 6 years.
• Information about where the crypto is stored.
• Whether a “mixer” or “tumbler”³ was used, along with the reason it was used.

Next, the taxpayer must be prepared to do the following in exchange for a decreased risk of criminal prosecution:

• Pay in full all tax and interest on the past 6 years of tax deficiencies.
• Pay a civil fraud penalty of 75% on the year with the highest tax liability.

Conclusion

These changes to the VDP instructions should eliminate any doubt that the IRS intends to pursue crypto enforcement. The VDP can be a good option but one that should not be taken without a full understanding of its requirements, as well as the potential benefits and drawbacks. It is worth noting that other options exist where the lack of reporting was not “willful.”

¹ Including transactions in virtual currency, such as the receipt, sale, exchange, or other disposition of financial interests in cryptocurrency and related financial vehicles. 
² I.R. 2022-33, IRS Announces Update to the Form 14457, Voluntary Disclosure Practice Preclearance Request and Application (Feb. 15, 2022). 
³ Generally, these terms refer to services utilized to further increase the anonymity of crypto currency transactions and holdings.