Is the IRS Cracking Down on Crypto?

In May 2023, President Biden posted a tweet taking aim at tax policies that benefit ‘wealthy crypto investors’.

While many in the crypto ecosystem criticized President Biden’s statement for being misleading, the tweet is indicative of a wider phenomenon: the federal government 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 — which means the IRS is paying closer attention to crypto transactions.

In this article, we’ll explore the different ways in which crypto tax fraud is increasingly becoming a focus for regulators — and how investors can stay proactive when it comes to reporting taxes and avoiding future trouble with the IRS.

The end of ‘gray area’ tax policies

Cryptocurrency transactions often reside in a ‘gray area’ of the tax code. Because the IRS has not released complete guidance on NFT and DeFi transactions, many investors have for years taken aggressive approaches to tax reporting to minimize their tax liability.

Recently, the IRS has taken steps towards providing more clear guidelines for these transactions. In March 2023, the IRS issued guidance for NFTs for the first time — detailing the circumstances when NFTs are considered collectibles and taxed accordingly.

It’s likely that more cryptocurrency guidance is due in the months ahead. According to Julie Foerster, the IRS’s digital assets director, the agency is set to implement a new operating plan for dealing with cryptocurrencies in the next 12 months.

In addition, the federal government is looking to close ‘loopholes’ that have been available for cryptocurrency investors through legislation. The Biden Administration’s latest budget package would expand the wash sale rule to cryptocurrencies — restricting crypto investors’ ability to claim capital losses.

How the IRS is cracking down on pseudo-anonymous transactions

In addition to publishing more guidance for cryptocurrency, the IRS has been cracking down on crypto tax fraud taking place on exchanges and on the blockchain.

As early as 2016, the IRS issued Coinbase a John Doe Summons — requiring the exchange to turn over customer records to the federal government.

Tax regulations on centralized exchanges are only set to tighten in the years to come. The 2021 Build Back Better Act requires cryptocurrency exchanges to issue mandatory 1099 forms reporting capital gains and losses to both customers and the IRS.

Of course, the IRS is not limiting its focus to centralized exchanges. In recent years, the tax agency has paid closer attention to on-chain tax fraud.

Currently, the IRS works with contractors like Chainalysis to analyze the blockchain and match ‘anonymous’ wallets to known investors. It’s been estimated that these partnerships have 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 sanctioned the privacy-focused Tornado Coin — making it illegal for Americans to use.

An increase in funding for the IRS

It’s likely that the IRS will only be focusing more attention on the cryptocurrency industry in the years to come. While the IRS has been called an ‘underfunded’ institution in years past, this is changing as the agency has recently picked up meaningful funding from the Biden Administration. The Inflation Reduction Act of 2022 gave $80 billion in new funding to the organization over the next ten years.

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

What steps should I take to accurately report my taxes?

With the increased attention on the cryptocurrency ecosystem, investors should be proactive in reporting their capital gains and income. Here are a few steps you can take to make sure that you’re staying compliant with tax law.

1. Keep track of your transactions: To accurately report your capital gains and losses, it’s important to keep a detailed record of all of your cryptocurrency transactions. This includes a complete history of all your trades and transfers across all of your wallets and exchanges — including the date the transaction took place and the fair market value of your crypto at receipt and disposal.
2. Find the right resources: To simplify the process of reporting your cryptocurrency taxes, it’s important to find the right tools. Crypto tax software can automatically sync to your wallets and exchanges — helping you keep track of your gains, losses, and income! If you feel uncomfortable reporting your taxes yourself, you can reach out to a tax professional with expertise in cryptocurrency.
3. Submit an amended tax return: If you haven’t reported your cryptocurrency taxes in prior years, you should file an amended tax return. You have three years from the date of filing to amend your tax return and ensure that your previous crypto transactions are reported accurately. Remember, the IRS is typically more lenient to investors who make a good faith effort to accurately report their taxes.

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

In conclusion

Cryptocurrency has entered the mainstream — which means the IRS is paying closer attention to the ecosystem than ever before. To avoid civil and criminal penalties, investors should be diligent in reporting their gains, losses, and income to the IRS.