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How the IRS Will Get Crypto Tax Dodgers

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Virtual currencies, such as bitcoin and ethereum, are treated by the Internal Revenue Service (“IRS”) as property. In other words, cryptocurrencies are taxed similarly to how stocks and real property are taxed. However, many crypto holders have been evading taxes, which has led to a “tax gap” — the difference between taxes paid and taxes owed. According to IRS chief Charles Rettig, the U.S. is losing approximately a trillion dollars each year in unpaid taxes, and the rising tax gap is believed to be because of the cryptocurrency market. [1] 

To combat this substantial amount of unpaid taxes, the White House is planning to give the IRS an extra $80 billion as well as new powers targeted towards catching tax dodgers (which will include people parking their money in crypto form instead of cash). The IRS has even recently buckled down on sending more subpoenas to centralized crypto exchanges in the hopes of getting better information on noncompliant U.S. taxpayers. These efforts may very well prove to be fruitful as the IRS has had many successes already in collecting revenue. As Shehan Chandrasekera, a CPA and head of tax strategy at CoinTracker.io, a crypto tax software company, has said, “[h]istorically, if they spend $1 for any type of enforcement activity, they make $5 . . . I think crypto enforcement activities are even higher than that”. [2] 

Current regulations have actually made it too easy to unintentionally cheat crypto taxes. This is partially due to the IRS making it difficult to report this kind of information. The first time the IRS even explicitly asked taxpayers about whether they had dealt in cryptocurrency was in the 2019 tax year. The question itself was vague (“at any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”), and, more importantly, it was asked on form Schedule 1, which is not filed by everyone. The IRS tried to correct this issue in 2020 by moving the virtual currency question to the top of Form 1040, which is used by those filing an annual income tax return. However, although the question became almost impossible to miss, tax filers still generally have no idea about how to calculate their capital gains and losses within cryptocurrency. This is virtually a non-issue for those trading securities through a brokerage, because traders will normally get a Form 1099-B which spells out transaction proceeds. The difficulty for crypto traders is that many crypto exchanges fail to report any information to the IRS. [3] 

Some crypto exchanges have tried to resolve this by issuing a 1099-K tax form, which was traditionally given to those making at least 200 transactions worth an aggregate of at least $20,000. However, issuing a 1099-K does not remove all the reporting issues because the form only reports the total value of transactions, and the total value does not account for how much money someone initially paid to purchase cryptocurrency (the “cost basis”), thus making it difficult to calculate the actual taxable gain. This confusion has led to many tax filers overreporting their income. Even more confusing are the constantly changing tax rules. [4]

President Biden’s 2022 budget proposal could lead to several new cryptocurrency reporting requirements, including mandated business reporting of all cryptocurrency transactions valued over $10,000 and having crypto asset exchanges and custodians reporting data on user accounts conducting at least $600 worth of gross inflows or outflows in a year. Until now, taxpayers’ cryptocurrency holdings have been in a reporting gray zone. Because of the latest efforts from the IRS and President Biden, that reporting gray zone may soon become much less muddled and more regulated as the IRS and Biden crack down on those trying to evade taxes on their crypto wallets. Traders should try to remain compliant with all tax reporting requirements by keeping track of tax forms produced by crypto exchanges, such as Coinbase’s 1099-MISC, and separately tracking their initial payments and every single crypto transaction. Traders should keep in mind that they need to pay taxes on the fair market value of the coins mined at the time of receipt. [5]

[1] MacKenzie Sigalos, “How the IRS is trying to nail crypto tax dodgers”, CNBC, 14 Jul. 2021, https://www.cnbc.com/2021/07/14/irs-new-rules-on-bitcoin-ethereum-dogecoin-trading.html, acc. 16 Jul. 2021.

[2] Ibid.

[3] Ibid.

[4] Ibid.

[5] Ibid.

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