Cryptocurrency tax enforcement is here, and many taxpayers are losing sleep over their unreported income. Although cryptocurrency is a digital representation of value that functions in the same manner as USD, the Internal Revenue Service (IRS) considers cryptocurrency to be “property” for tax purposes.1 This means that cryptocurrency is taxed the same way as any other capital asset you own, either at long term capital gains or at ordinary rates.2
However, due to the pseudo-anonymous and complex nature of blockchain technology and digital currency, the IRS has largely been reliant upon, and limited by, the self-reporting of taxpayers. Lately, the IRS has started taking matters in its own hands as many cryptopreneurs are underreporting their taxable income. The IRS is partly to blame for this as they haven’t made it easy for taxpayers to report this information. The IRS offers only general guidance about the records you’ll need “to establish the positions taken on tax returns.”3 Even so, the IRS has made it clear that it wants a piece of the action, or else.
Crypto Tax – IRS Top Enforcement Priority
The IRS has put crypto front and center for this tax filing season as many investors are making thousands of dollars by trading Bitcoin, selling their jpeg rock NFT’s, breeding CryptoKitties, and investing in various dog meme-coins. A recent study estimates that 48% of taxpayers bought cryptocurrency in the first half of 2021.4
When preparing your crypto taxes, IRS Form 1040 will likely ask taxpayers, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in virtual currency?” In answering this question, it’s important for investors to know the difference between taxable and non-taxable cryptocurrency transactions. A taxable transaction includes; receiving cryptocurrency, exchanging cryptocurrency for goods or services, exchanging cryptocurrency for another cryptocurrency, and selling your cryptocurrency.5 Just purchasing Bitcoin, or moving Bitcoin from one wallet to another is not a taxable transaction and does not have to be reported for federal income tax purposes.
How To Report Blockchain Asset Income
Those who handle transactions in cryptocurrency must meet their tax obligations like any other taxpayer. To report your cryptocurrency income and avoid an audit, you’ll need to calculate your gains and losses, complete IRS Form 8949, include your totals from 8949 on Form Schedule D, and, if necessary, include any ordinary crypto income. Capital gain is the difference between the purchase price (cost basis) and the sale or exchange price.
While you’ll need to report your capital gains and losses on Form 8949, you’ll also need the following information on each individual transaction: description of the property you sold, date acquired, date sold, sales price, fair market value, cost basis, and gain or loss. This means that investors need to keep careful records of their virtual currency transactions, which can get complicated if you’re swapping cryptocurrencies or using different exchanges, like Coinbase and Uniswap. Some exchanges may provide taxpayers with a Form 1099-K with these details – if they’ve had gross payments exceeding $20,000 and they’ve made 200 transactions.6 The total net gain or net loss is then transferred and included on Schedule D. Lastly, if you earned any cryptocurrency through forks, airdrops, staking, or mining, you’ll need to report it as ordinary income on either Schedule 1, Schedule B, or Schedule C.
Know that if you’ve received a 1099-K from Coinbase or another exchange, the IRS has received one too and filing is a must. If you fail to report your cryptocurrency income, the IRS has numerous information-gathering tools to enforce its taxing power, including a John Doe summons and the National Crypto Enforcement Team (NCET).
Potential Risks of Tax Evasion
Courts have authorized service of John Doe administrative tax summons. A John Doe summons allows the IRS to obtain the names, requested information and documents concerning all taxpayers in a certain group.7 A cryptocurrency John Doe summons directs cryptocurrency exchanges to produce records identifying U.S. taxpayers who may have failed to comply with internal revenue laws, along with documents relating to their cryptocurrency transactions.8
Cryptocurrency exchanges like Coinbase, Kraken, and Circle have all been ordered to provide information on their users.9 Using this information, the IRS has conducted audits and sent over 10,000 warning letters to people who failed to report their crypto income.10 Receiving one of these letters could result in an audit, additional tax, interest, penalties, and possible criminal prosecution. The John Doe summons should send a clear message to all cryptocurrency investors – you can HODL, as long as you are compliant with your tax reporting obligation.
Failing to report your taxable crypto income could result in having the NCET come knocking on your door. On October 6, 2021, the U.S. Department of Justice announced the creation of a NCET in response to what the agency sees as a wide range of crimes being perpetrated through use of cryptocurrency.11 The announcement of the NCET is a broader federal effort to increase cryptocurrency-related enforcement. Specifically, the NCET will:
- Investigate and prosecute cryptocurrency cases;
- Develop strategic priorities for investigations and prosecutions involving cryptocurrency;
- Identify areas for increased investigative and prosecutorial focus, including professional money launderers and financial institutions working with cryptocurrency;
- Develop and maintain relationships with federal, state, local, and international law enforcement agencies that investigate and prosecute cryptocurrency cases;
- Train and advise federal prosecutors and law enforcement agencies in developing investigative and persecutorial strategies;
- Support the coordination and sharing of information and evidence among law enforcement offices to maximize the effectiveness of the Department’s investigations, prosecutions, and forfeitures involving cryptocurrency;
- Collaborate and build relationships with private sector actors with expertise in cryptocurrency matters to further the criminal enforcement mission.
The federal government has a growing security interest in Bitcoin and other cryptocurrencies, and the NCET looks to protect that interest. Specifically, NCET looks to ensure regulatory compliance in the cryptocurrency market by going after bad actors, including those who commit tax fraud. Although tax fraud may not be at the top of the list for the NCET, you can rest assured that it will assist the IRS in its pursuit of tax reporting compliance.
Let Gordon, Delic & Associates Help You Navigate Digital Property Taxes
The experienced cryptocurrency attorneys at Gordon, Delic and Associates can help you with all of your cryptocurrency tax needs, including determining the best accounting method when calculating your gains and losses (FIFO; LIFO; HIFO), reporting requirement for your cryptocurrency taxes, defending against any cryptocurrency audits, responding to IRS cryptocurrency letters, and correcting any previous years’ tax returns.
Taxes are one of life’s certainties, and cryptocurrency is no exception. Our team is happy to answer any cryptocurrency question you have. Stay ahead of the IRS and contact us or call us at (208) 900-9509 today.