Is the IRS cracking down on crypto?

In May 2023, President Biden posted a tweet focusing on tax policies that benefit “wealthy crypto investors.”

While many in the crypto ecosystem criticized President Biden’s statement for being misleading, the tweet points to a broader phenomenon: the federal government is cracking down on crypto tax evasion.

Cryptocurrency is no longer a niche ecosystem under the radar of legislators and tax authorities. Crypto is more mainstream than ever — meaning the IRS is paying more attention to crypto transactions.

In this article, we explore the various ways crypto tax fraud is increasingly becoming a focus of attention for regulators – and how investors can stay proactive when it comes to declaring taxes and avoiding future issues with the IRS.

The end of tax policy in the ‘grey zone’

Cryptocurrency transactions are often in a “grey area” of tax law. Because the IRS has not released full guidelines for NFT and DeFi transactions, many investors have taken aggressive tax filing approaches for years to minimize their tax liability.

Recently, the IRS has taken steps to provide more clear guidelines for these transactions. In March 2023, the IRS first issued guidelines for NFTs – detailing the circumstances in which NFTs are considered collectibles and taxed accordingly.

It is likely that more cryptocurrency guidance will follow in the coming months. According to Julie Foerster, the director of digital assets for the IRS, the agency will implement a new operational plan for handling cryptocurrencies over the next 12 months.

In addition, the federal government is trying to close “loopholes” that were available to cryptocurrency investors through legislation. The Biden administration’s latest budget package would extend the wash-sale rule to cryptocurrencies — limiting crypto investors’ ability to claim capital losses.

How the IRS is cracking down on pseudo-anonymous transactions

In addition to publishing more cryptocurrency guidelines, the IRS has been cracking down on crypto tax fraud that is happening on exchanges and on the blockchain.

Back in 2016, the IRS Coinbase issued a John Doe Summons requiring the exchange to hand over customer data to the federal government.

The tax rules for centralized exchanges will only get stricter in the coming years. The Build Back Better Act of 2021 requires cryptocurrency exchanges to issue mandatory 1099 forms that report capital gains and losses to both clients and the IRS.

Of course, the IRS doesn’t limit its focus to centralized exchanges. In recent years, the Tax and Customs Administration has paid more attention to chain fraud.

Currently, the IRS is working with contractors like Chainalysis to analyze the blockchain and match “anonymous” wallets with known investors. It is estimated that these partnerships helped the IRS seize more than $10 billion in Bitcoin.

In addition, the federal government is taking active steps to deter investors from using privacy coins that could potentially be used for tax evasion. In 2022, the Treasury Department approved the privacy-focused Tornado coin, making its use by Americans illegal.

An increase in funding for the Tax and Customs Administration

It is likely that the IRS will only pay more attention to the cryptocurrency industry in the coming years. While the IRS has been called an “underfunded” institution in recent years, this is changing as the agency recently received significant funding from the Biden administration. The Inflation Reduction Act of 2022 gave the organization $80 billion in new funding over the next ten years.

While it’s unknown how much of this funding will be spent specifically fighting crypto tax fraud, IRS commissioners singled out cryptocurrency as a major contributor to America’s annual tax gap. Therefore, it is reasonable to assume that more funding for the IRS will lead to increased scrutiny of cryptocurrency investors.

What steps should I take to correctly declare my taxes?

With the increased focus on the cryptocurrency ecosystem, investors need to be proactive about reporting their capital gains and earnings. Here are a few steps you can take to ensure you stay tax compliant.

1. Track your transactions: To accurately report your capital gains and losses, it is important to keep a detailed record of all your cryptocurrency transactions. This includes a full history of all your transactions and transfers across all your wallets and exchanges – including the date the transaction took place and the fair market value of your crypto upon receipt and removal.
2. Find the right resources: To simplify the process of filing your cryptocurrency taxes, it is important to find the right tools. Crypto tax software can automatically sync with your wallets and exchanges – so you can keep track of your profits, losses and income! If you are not comfortable doing your own tax returns, you can contact a tax professional with cryptocurrency expertise.
3. Submit an amended tax return: If you have not filed your cryptocurrency taxes in previous years, you must file an amended tax return. You have three years from the filing date to amend your tax return and ensure that your past crypto transactions are accurately reported. Remember, the IRS is generally more lenient on investors who make a good faith effort to accurately report their taxes.

Remember that tax evasion is considered a crime. The maximum penalty for tax evasion in the United States is $250,000 and up to five years in prison. Plus, there’s no time limit on how far back the IRS can check you in cases of outright tax fraud.

Finally

Cryptocurrency has gone mainstream, meaning the IRS is paying more attention to the ecosystem than ever before. To avoid civil and criminal penalties, investors must carefully report their profits, losses, and income to the IRS.