The IRS Is Tracking Down Crypto Tax Evaders

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Until recently, many people thought that purchases and money transfers made with cryptocurrency were safe and secret. The convenience and anonymity led many people—including criminals—to use it for shady and illegal deals—such as profiting from illegal porn and drug transactions. Others thought they could profit and never have to report it to the Internal Revenue Service (IRS). Now the agency has found a way to crack the code and learn about those supposedly secret deals.

After breaking the cryptocurrency code, the dominoes began to fall. Recent catches involved cases worth $3.6 billion and $10 billion, with many people being arrested. The IRS, and people working with the agency, have united to find tax cheats and illegal activities using crypto.

Cracking the Cryptocurrency Code

Cryptocurrency created a way to transfer assets (money) without revealing someone’s identity. The system used keys that identified individuals, and unless the buyer or seller revealed their name, it was a secret transaction—and many hoped it would stay that way.

Every cryptocurrency uses a blockchain system. In it, ledgers are created with every transaction carefully recorded. They are permanent and cannot be changed once entered into the system. The information also cannot be erased or replaced, which gives the IRS good data to base a case on—if it can crack the code.

Multiple computers create a network with each one having duplicate ledgers, enabling the data to be secure and non-modifiable. The breakdown of one computer will not hurt the system or records. IRS investigations found a way to identify individuals involved in crypto transactions by using publicly available records.

Advantages of Cryptocurrency

The main idea behind cryptocurrency is that it eliminates any centralized banking system (government control), but can still permit nearly instant and inexpensive methods of transferring money. It has many legitimate uses, BraveNewCoin says, besides enabling private transactions, including protection from your cash accounts being frozen by the government, letting you invest in new business startups, travel anywhere, buy some luxury cars, and more.

Crypto gives you several advantages over other financial methods of transferring money. When using a bank, it can take up to five days to complete a transaction. Transactions using crypto are completed very fast and do not require verification by a third party. It also enables you to transfer money to most places worldwide. Earnings from crypto trading can exceed more than 10 percent—at times.

On the negative side, crypto remains volatile and you can lose money if you hold it in crypto accounts. Cryptocurrencies are not backed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency.

Paying for Codebreakers

A couple of years ago, Forbes reported that the IRS was willing to pay up to $625,000 to people who could crack Monero or Lightning and get useful information. The IRS became suspicious when many people did not report any income or earnings from cryptocurrency between 2013 and 2015. The number of people reporting any income had actually dropped during that period. It resulted in the current crackdown.

Starting in 2019, the IRS began sending letters to people warning them to update their past tax forms if they did not report all their crypto income. The letters were sent to people they know that have crypto accounts, which were discovered by analyzing the data.

The IRS is very interested in collecting taxes that should have been paid. Since the IRS is hiring an additional 80,000 more tax agents, you can be sure there will be a lot more tax auditing taking place soon. The agency encourages everyone that has not reported taxable cryptocurrency transactions to amend their past tax forms and pay the taxes due, along with any penalties that may be applied.

Tax on Cryptocurrency

Whenever you make a gain on your crypto transactions, the IRS will know about it. Crypto companies are required to report to the IRS on a 1099 anyone that has made a gain on their accounts. According to Engiven, the IRS summoned Coinbase between 2013 and 2015 to find out about its customers. With this information, the IRS determined that about 10,000 people had failed to report their crypto profits.

Failing to provide accurate crypto tax reporting to the IRS could result in fines or jail time. There is a maximum penalty of five years for tax evasion and a fine of $250,000—or twice the amount of taxes owed.

Cryptocurrency should be reported as capital gains or losses on Schedule D. Capital gains are made when you sell it for more than the purchase price.

How to Avoid Crypto Taxes

Even though no one likes to pay taxes, there are ways to do it safely without being concerned about the IRS looking over your shoulder. Buying crypto through a retirement account can give you the break you need. Buying crypto inside a traditional IRA (you may need to get a self-directed IRA to do this), EscapeArtist says, will enable you to avoid taxes until you start taking distributions. If you buy crypto from inside a Roth account, you will not pay any taxes on the distributions because contributions to Roth accounts are made after-tax.

CoinLedger reveals that you can also choose to hold your crypto profits for more than 12 months. When you do, it falls under the long-term capital gains tax, which enables you to pay about half the taxes, compared to withdrawing your profit in less than 12 months.

Making sure you report all your profit from cryptocurrency is a good idea. It will help you stay on good terms with the IRS and avoid fines or jail time. Talk to a financial expert to determine the best way to legally reduce your crypto taxes as much as possible.

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