Blockchain Services
Amanda S. Marshall
Former U.S. Attorney
(Local Counsel)
Lynette Byrd
Former Assistant
U.S. Attorney
Roger Bach
Former Special
Agent
(OIG & DEA)
Joe Brown
Former U.S. Attorney
Dr. Nick Oberheiden
Attorney & Founder
In general, the U.S. tax system relies on the voluntary compliance of taxpayers. This means that the IRS expects you to report all taxable transactions in a given year because you are required to do so by the internal revenue code. Failing to properly report your cryptocurrency transactions could result in hefty penalties. For these reasons, to avoid penalties or unexpected tax liability, you should be proactive in reporting your transactions to the IRS. Still many taxpayers fail to properly report their cryptocurrency transactions to the IRS. This can occur for any number of reasons, the most common of which being that the taxpayer did not know they needed to report the transaction or they did not understand what exactly needed to be reported. The IRS has adopted several different methods to track cryptocurrency transactions. These methods enable the IRS to encourage voluntary reporting and, in some cases, prosecute taxpayers that have tried to avoid paying taxes on their cryptocurrency holdings.
Since 2014, the IRS cryptocurrency was stated that virtual currency is treated as property for federal income tax purposes. Even so, very few taxpayers were reporting their cryptocurrency transactions and between 2013 and 2015 less than a thousand taxpayers filed returns reporting cryptocurrency. Over the years, the IRS has attempted to enforce the tax laws on cryptocurrencies. In 2019, to try to encourage more voluntary compliance, the IRS sent more than 10,000 letters to people it believed may have failed to report virtual currency income. Also in 2019, the IRS added a question to form Schedule 1 explicitly asking taxpayers whether they had profited from cryptocurrencies that year. The new question on form Schedule 1 asked whether the taxpayer had, at any time during 2019, received, sold, sent, exchanged, or otherwise acquired a financial interest in any virtual currency. In 2020, the IRS moved the question about virtual currency to form 1040, which is used by all individuals filing an annual income tax return.
If a taxpayer does not voluntarily disclose his or her cryptocurrency transactions, how does the IRS learn about them? First, many cryptocurrency exchanges report transactions that are made on their platforms directly to the IRS. If you use an exchange that provides you with a form 1099-K or form 1099-B, there is no doubt that the IRS knows that you have reportable cryptocurrency transactions. If you have more than $20,000 in proceeds and at least 200 transactions in cryptocurrency in a given tax year, you should receive a form 1099-K reflecting your proceeds for each month. Exchanges are required to create these forms for users who meet these criteria. A copy of this form is sent directly to the IRS. If you file a tax return, and fail to include these amounts, the IRS computer system will automatically flag your return for under reporting. Similarly, if you receive a form 1099-B and do not report it on your tax return, it will likely be flagged for under reporting. Many exchanges, such as Coinbase, Kraken, Binance.us, Gemini, Uphold and other U.S. exchanges send reports directly to the IRS. As a result, if you receive any tax form from an exchange, the IRS likely already has a copy of it and you should report it on your return to avoid tax penalties.
Another method the IRS uses to track cryptocurrency and virtual currency transactions is to issue subpoenas. Over the past few years, the IRS has issued many subpoenas to several exchanges, ordering them to disclose certain user accounts. In 2018, for example, Coinbase was forced to disclose around 13,000 user accounts, including taxpayer identification number, name, birth date, address, records of account activity, transaction logs, and all periodic statements of account or invoices. Although a federal court required the IRS to reduce the scope of its subpoena, which originally sought information from around 480,000 users, the court did compel Coinbase to turn over the information the IRS requested for about 13,000 users. Similarly, the IRS has issued record requests to other exchange operators such as Kraken and Circle. On another occasion, the IRS sent a subpoena to Bitstamp asking it to release information about a U.S. taxpayer that used the exchange.
Through these subpoenas, the IRS can uncover whether, and how often, some U.S. taxpayers are engaging in cryptocurrency or virtual currency transactions that are not being reported on their tax returns. Although issuing these requests to exchanges one at a time can be cumbersome, it can be an effective way to capture noncompliant U.S. taxpayers. After being compelled to turn over user information, Coinbase notified the affected users that it would be providing their information to the IRS. If you have reason to believe that your transaction information could have been provided to the IRS in response to a subpoena, it is important for you to proactively address any potential under reporting. Failing to do so could result in an unexpected tax liability or financial penalties. For serious offenders, the IRS can charge taxpayers with criminal tax evasion.
Since it began ramping up enforcement on cryptocurrency transactions, the IRS has consulted various blockchain companies to stay ahead of changes in the system. With help from blockchain companies, the IRS is using advanced data analysis, pattern recognition, and machine learning to identify suspicious activity across several exchanges, and billions of transactions. The IRS will likely use data analytics such as these to increase its ability to track cryptocurrency transactions and go after U.S. taxpayers that under report.
In general, the trend is towards increased enforcement of the crypto tax laws on cryptocurrency transactions. Every additional dollar invested in IRS enforcement generates around $6 in return. For virtual currency, this return is likely much higher. If you engage in transactions with virtual currency, including buying, selling, receiving, sending, exchanging, or otherwise acquiring a financial interest in any virtual currency, you should be prepared to report your transactions to the IRS. If you used an exchange that provided you with a form 1099-K or form 1099-B this should be simple. But if you have not received one of these forms from your exchange, you must keep your own, accurate record of any transactions so that you can calculate your tax liability correctly. In those cases, or if your tax situation is particularly complex, you may need to consult a crypto tax professional or other advisor who can assist you with reporting your transactions in virtual currency to the IRS.
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