When cryptocurrency first started to hit the mainstream, it was lauded as a private way of transferring and earning money that sat outside the world of traditional finance. People quickly hopped on, utilizing it as a way to send assets without being tracked. But if there’s a way to earn money, know that the IRS will find a way to track and tax it.
It’s the same with cryptocurrency—the IRS has aggressively ramped up its enforcement of crypto monitoring and compliance. They have secured additional funding and plan on hiring agents whose only job is to track cryptocurrency transactions.
All that being said, you should expect that your cryptocurrency transactions are visible to the IRS—and that means paying taxes on your profits. What happens if you don’t track your profits, don’t report them, or fail to pay taxes on them? Keep reading to learn more about the potential consequences or contact us at the W Tax Group to get help now.
The Risks of Not Reporting Cryptocurrency
Many cryptocurrency investors, faced with the knowledge that the IRS is watching them closely, are now asking: what happens if you don’t report cryptocurrency on taxes?
Failing to report cryptocurrency gains on your taxes can result in a wide range of penalties. You may be audited and be charged penalties on top of your unpaid taxes. You can even face legal issues if the IRS decides that you committed criminal tax evasion by not reporting your crypto.
As the IRS moves forward with tax returns for 2023, you can expect to see a lot of new cryptocurrency tax evasion cases in the news. Even if you look back in the last few years, you’ll see that the IRS has collected billions of dollars by pursuing these cases.
In one major 2021 case, the founders of a crypto ICO pled guilty to tax evasion. They defrauded investors of millions of dollars and used their investments for their own personal expenses. Those claims were handled by the Securities & Exchange Commission (SEC). The IRS dealt with the founders’ failure to claim their crypto income on their taxes.
In total, the tax loss amounted to more than $1.6 million dollars. The penalty? Up to five years in prison. This all started in 2016 and didn’t come to a head until 2021—even if you think you’ve skated under the IRS’s radar, you probably haven’t.
Tax Rules for Crypto Transactions
The IRS views cryptocurrency as property. As a result, the tax principles and laws that apply to all property transactions typically apply to transactions involving cryptocurrency. This includes convertible virtual currency, cryptocurrency, NFTs, and stablecoins. The IRS does not view them as currency because they are not the actual money used by the USA or a foreign country.
This means that you have to report losses and gains when you have a cryptocurrency transaction. A transaction occurs when you sell or exchange cryptocurrency. One common issue that occurs is a misunderstanding of these requirements.
If you trade crypto on a platform, you may not actually cash out money if you then use those proceeds to buy other cryptocurrency coins. However, you are still taxed on the profit you made from the initial sale, and that gain must be reported to the IRS. Many people still believe they only have to report profit when converting their crypto to cash. But that is not the case.
You also need to report crypto if you use it to make a purchase. Here’s an example: say that someone gives you crypto as a gift. Its value on the day you receive it is your basis. Imagine it’s worth $1,000 when you receive it. You hold the crypto for a few months and then you decide to buy some items. When you use the crypto, it is worth $1,500. At this point, you have a $500 gain, and you must report it to the IRS on your tax return.
Reporting Requirements for Cryptocurrency
Whether you have gains from cryptocurrency transactions, you must report them to the IRS. This is where some people go wrong—they think that they only have to report cryptocurrency income if they receive a 1099-MISC because they’ve received at least $600. While that is the threshold for a 1099 form, you must report all income on your tax return.
It’s obvious why the IRS wants you to report your gains—you have to pay taxes on them. However, you should also report your crypto losses. When you sell your cryptocurrency for less than you paid for it, that’s a loss, and you can use it to your benefit.
Utilizing Crypto Losses in Tax Filings
When you have a loss, it cancels out gains within the same year. Essentially, your losses and gains are compiled, and whatever gains remain are what you are taxed on. When you report your losses, you are either increasing your refund or decreasing the amount of taxes you must pay in.
What if you combine your gains and losses and you still have a loss? In that case, your losses can count against up to $3,000 of your income. From there, your losses can be carried forward into the next year and used to decrease your tax burden.
Short-Term Vs. Long-Term Crypto Gains and Losses
Don’t forget to categorize your crypto trades and sales into short-term and long-term categories. Short-term gains and losses occur when you get rid of crypto after holding it for less than a year. Long-term gains and losses are reserved for crypto you have had for more than a year.
The tax rate on long-term capital gains is usually 15%, but it’s 0% if your income is below a certain level. Short-term gains, in contrast, are taxed at the same level as your income.
How to Deal With Unreported Cryptocurrency
If you’re reading this and you have not reported your cryptocurrency on your taxes, you may be starting to worry. Try not to panic—there are different ways to handle this issue and ensure that you are compliant with IRS requirements. Here are the main options.
Amend Your Tax Return
One option to consider is amending past years’ tax returns to report your cryptocurrency losses and gains. You can amend your return with Form 1040-X. You generally have three years from the date you filed a tax return to amend it for a refund, but if you’re not claiming a refund, you can amend your return at any time.
File a Voluntary Disclosure
The Voluntary Disclosure Practice allows you to come forward about your unreported crypto, while reducing your risk of criminal exposure. You cannot take advantage of this program if the IRS has already reached out to you about your failure to pay crypto taxes or if they have started legal proceedings against you. If your failure to report has not yet been caught, this may be a good option to consider. It allows you to get caught up on past-due taxes and avoid further issues.
Consult With a Tax Attorney
What if neither of these is an option for you? If the IRS has found your unreported gains, we recommend speaking to a tax attorney with experience in cryptocurrency. Depending on how much you did not report, how far back your crypto gains go, and whether or not the IRS believes your failure to pay was intentional, there may be different strategies to consider.
It is crucial to talk with an attorney to avoid the worst possible outcomes of the IRS investigation.
Penalties for Unreported Cryptocurrency
The IRS can levy steep penalties against those who evade taxes via fraud. Not only will you have to pay the amount you would have owed if you’d filed correctly, you may also have to pay a penalty as high as 75% of the total amount due. This fraud penalty is capped at $100,000 in fines for an individual.
If you understated your income, the penalty is 20% of the underpayment that occurred due to negligence. On top of all of this, you also have to pay interest on penalties.
How Does the IRS Catch Tax Evaders?
Those who believe the blockchain to be anonymous often doubt that the IRS can really figure out who is evading their taxes. However, know that crypto exchanges do cooperate with the IRS. They are legally required to comply.
Even the exchanges that initially resisted efforts to provide user data were later forced to share the data via John Doe summons. To be on the safe side, never assume that your cryptocurrency transactions are private. Assume that they are just as easily tracked as your bank transactions because for the IRS, they basically are.
Additionally, if you have more than $600 in gains during a year, your crypto exchange will likely send you a 1099, and they will also send a copy to the IRS. If you don’t report these amounts on your tax return, the IRS will have obvious proof that you underreported your gains.
Special Considerations
Since cryptocurrency is still relatively new in the grand scheme of everything, there are still many situations that aren’t as obvious to taxpayers. If you buy cryptocurrency but do not sell or trade it, you do not have to report it to the IRS. However, if you receive interest on your held cryptocurrency, that is considered income and must be reported.
If you sell cryptocurrency at the same price you bought it for, you have neither a gain nor a loss. Consequently, it has no effect on your taxes.
Other situations may arise and complicate your taxes. If you are paid for your work in cryptocurrency, you will need to report that as income on your tax return. Your crypto earnings will be treated the same way as income earned in U.S. dollars. The amount you’re taxed on is equal to the value of the cryptocurrency on the day you receive it. If the value of your cryptocurrency then increases between when you receive it and when you sell it for money, you pay capital gains tax on the difference.
Get Help With Unreported Crypto
The IRS will be cracking down on unreported cryptocurrency, so this is the ideal time to make sure that you are keeping accurate records and reporting all of your gains and losses. If your bookkeeping hasn’t exactly been perfect in recent years, set aside an afternoon to go through your records and find out if you have any unreported gains.
If you do, it may be time to look into options that allow you to become compliant with IRS regulations without facing additional penalties.
Not sure where to start? We can help. At W Tax Group, we help clients just like you untangle complex tax problems. Our staff works exclusively in tax law, giving us the insight and experience necessary to help you navigate your crypto tax concerns. Set up a consultation now to discuss your issues in greater detail, get our professional advice, and come up with a plan. You can call us at 877-500-4930 or reach out online to get started.
