Cryptocurrency has led to tax evasion on a grand scale. The IRS is privy to it and is taking steps to build cases against taxpayers.
Millions of cryptocurrency transactions are unreported each year. While taxpayers believe they will go undetected and avoid penalties, that is going to change soon.
In 2019, the IRS sent 10,000 letters to crypto taxpayers. These letters are just the start of persecuting tax evaders. Anyone receiving the letter can’t claim ignorance because they now know.
In addition to the letters, Form 1040 in 2019 has a question about cryptocurrency about whether the person completing the form sold, sent, or exchanged cryptocurrency. Not checking this box falls under “willful failures” which can lead to higher penalties.
In addition to investigating potential tax evasion, the IRS Criminal Investigation Division is meeting with authorities in other countries to formulate strategies to prevent and identify tax evasion.
Cryptocurrency is taxable. Anyone who receives cryptocurrency has to pay taxes on it. When buying cryptocurrency, it is important to document when it was purchased, how much it cost and how much was received.
Losses should also be documented, as those can be used as deductions. Of course, those losses aren’t as much of a problem when it comes to reporting - it’s more so the income or gains since that can lead to significant tax liability.
All cryptocurrency must be reported in fair market value of when it was received. This is why it must be documented at the time of the transactions.
The IRS knows the challenges miners face, as it can be difficult to identify exact timing when mined cryptocurrency is received. Despite this acknowledgment, the IRS reports taxpayers should use the first-in-first-out (FIFO) method. This method identifies the mining processes to make keeping a detailed log easier.
Best efforts are what the IRS cares most about when it comes to mining. At this time, they don’t have a way to track the mining of virtual currency. Although, they can follow transactions once the currency is used, which is how taxpayers can get into trouble.
For previous tax returns, it’s a good idea to amend them or provide quiet disclosures. With the ability to go back five years, it’s better to correct mistakes before it is identified and regarded as fraud. Before stepping forward with an amendment or disclosure, speak to a tax advisor with experience in cryptocurrency for guidance.