The Taxman Cometh for the Crypto World

For anyone involved in the world of cryptocurrency, it’s been an interesting few years. Many early investors saw their chosen currencies explode in value, and then plunge soon after that. Throughout the roller coaster ride, regulators and government agencies struggled to make sense of what the crypto market actually was, how it was to be regulated, and which existing legal structures might apply.

One of the biggest grey areas that emerged from all of the scrutiny centered around how crypto assets would be treated for tax purposes, particularly in the United States, where so much of the market gains occurred. So far, there’s been no specific legal frameworks created in the US to deal with cryptocurrencies, but the IRS has issued a ruling that designates them as property — not money. That means they’re subject to capital gains tax just like stocks, bonds, and similar financial instruments.

In practice, that’s turned into something of a nightmare for anyone using a cryptocurrency as money rather than an investment vehicle. That’s because the IRS didn’t set a de minimis threshold for crypto transactions, meaning there would be tax due every time anyone used a cryptocurrency to make a purchase — no matter how small. The oversight means that it’s very (and some would say unfairly) difficult to keep track of your tax liabilities if you’re using cryptocurrencies on a frequent basis. The real result, if recent reports are accurate, is that many holders of cryptocurrencies threw their hands up in frustration and didn’t bother to report anything to the IRS about their cryptocurrency holdings.

Predictably, the IRS doesn’t appear to be taking that taxpayer apathy lying down. Instead, they’re joining a host of other government tax authorities in beginning a push to catch crypto-scofflaws and claim their share of the revenue generated in the market. For any of the countless individuals in the US that didn’t report the data about their crypto holdings to the IRS this April, that could mean serious trouble. For one thing, the IRS’s new focus on underreported cryptocurrency capital gains could serve as a red flag to trigger audits, and as anyone who’s ever been through one can tell you, those rarely end well for the taxpayer.

In fact, according to Tax Defense Partners, who specialize in resolving taxpayer disputes with the IRS, an audit can carry all kinds of negative consequences for taxpayers, including asset seizures, tax liens, and wage garnishments. They note that a lien can be especially troublesome, saying “A lien attaches to your current and future assets, such as real property. Liens can also affect your creditworthiness. Liens frequently will continue to exist after a taxpayer files bankruptcy.” That means the IRS has the power to go right after the debtor’s crypto assets, and it’s very difficult to stop them. The only real solution is to head off the problem by reporting capital gains on those assets the right way in the first place — and there are now technological means for taxpayers to do that.

The lack of clarity that surrounded the tax liabilities of cryptocurrency sales didn’t go unnoticed by entrepreneurs who sought to turn a major headache into a business opportunity. In fact, the need to create the tools to allow cryptocurrency holders and investors to track their transactions and complete the complex capital gains calculations (which are based on the asset’s value in US dollars at the time of sale) was so apparent that it has spawned a cottage industry of businesses aiming to corner the crypto-tax market.

The first sign of the industry’s recognition that it faced a tax reckoning was when leading crypto trading platform Coinbase announced that it was partnering with TurboTax to allow customers to export their crypto transactions into the popular tax preparation software for easier reporting. The second sign was the resurgence of Bitcoin Taxes, which was one of the earliest entrants to the crypto-tax business. Then, as if to signal the end of the “anything-goes” tax environment, global accounting powerhouse Ernst and Young announced this March that they were rolling out a new crypto-tax tool known as CAAT, which aims to make crypto reporting easier for institutional and other large investors. The bottom line here is that it’s becoming clear that those who shirked their obligation to report their gains (or losses) in cryptocurrency this year are skating on thin ice.

If you’ve made it this far and you’re one of the many people that didn’t voluntarily comply with the IRS reporting requirements for cryptocurrencies, you may be thinking: “I’ve been doing this for years… they’ll never notice.” If so, your luck may be about to run out. If you hadn’t heard, the aforementioned Coinbase lost a protracted fight over turning over transaction records to the IRS way back in March of 2018. Since then, they, and every other reputable exchange has been cooperating with IRS information requests. That means that it is only a matter of time before the massive tax bureaucracy works its’ way through the backlog of data they’ve already gotten and shows up at taxpayers’ doors looking for their due.

In short, that means that the clock is already ticking for everyone with potential cryptocurrency tax issue exposure to start making efforts to resolve those issues themselves before the IRS does it for them. That means going back through historical records and filing amended tax returns for as many years as is necessary. It’s not an easy thing to do, but nothing is gained by waiting — in fact, the IRS is going to keep piling interest on top of any back taxes owed until the balance is paid. That means crypto-enthusiasts face the very real risk of forfeiting a big chunk of whatever gains they’ve made to the government very soon. No one can know when it’s going to happen, but one thing’s for sure — the IRS never forgets a debt, and it’s never a good idea to get on their bad side.