For years, U.S. taxpayer cryptocurrency holdings have existed in a sort of reporting gray area. But now these crypto wallets are getting a lot of attention from the Internal Revenue Service and President Biden, who appear determined to crack down on tax fraud.
The timing makes sense.
The president needs to raise money, fast enough, for his own ambitious economic agenda. And the “tax gap,” that is, the difference between taxes paid and taxes owed, is a large stash of money ready to be plucked. IRS chief Charles Rettig says the country loses an estimated trillion dollars each year in unpaid taxes, and he attributes this growing tax gap, at least in part, to the rise of the crypto market.
The federal government is so convinced of the potential for overdue tax revenue that the White House wants to give the IRS an additional $ 80 billion and new powers to crack down on tax evaders, including those who put their money in crypto.
“The IRS’s mission is to collect revenue,” said Shehan Chandrasekera, CPA and head of tax strategy at CoinTracker.io, a crypto-tax software company.
“Historically, if they spend $ 1 on any kind of app activity, they earn $ 5… I think crypto app activity is even higher than that,” he said.
In the United States, it is easy to be an unintentional crypto tax evader.
For one thing, the IRS hasn’t really made it easy to report this information.
The 2019 tax year was the first time the IRS has explicitly asked taxpayers if they have dealt in crypto. A question on the Schedule 1 form read, “At any time in 2019, have you received, sold, sent, traded or otherwise acquired a financial interest in a virtual currency?” “
But experts said the question was vague and, most importantly, not everyone is tabling this specific document. A Schedule 1 is typically used to report income that is not shown on the Form 1040, such as capital gains, alimony, or gambling gains.
So in 2020, the IRS upped its game by moving the issue of virtual currency to the 1040 itself, which is used by all individuals filing annual tax returns.
“[They put it] right after your name and Social Security number, and before you enter any income or deduction numbers, ”explained Lewis Taub, CPA and Director of Tax Services at Berkowitz Pollack Brant. This made the question virtually impossible to miss.
But perhaps the biggest problem, according to Shehan, is that many filers have no idea how to calculate their crypto capital gains and losses.
If you trade through a brokerage house, you usually get a Form 1099-B describing the proceeds of your transaction, thereby streamlining the reporting process.
This doesn’t happen in the crypto world, Shehan said. “Many crypto exchanges do not report any information to the IRS.”
While some crypto exchanges have started issuing a tax form known as 1099-K – which is traditionally given to an individual who makes at least 200 transactions with a total value of $ 20,000 or more – in the context of cryptography, this form only reports the total value of transactions. The total value does not take into account how much the person paid for the cryptocurrency in the first place, which is known as the “cost basis”, making it difficult to calculate the taxable gain.
“A lot of people have actually overreported their income because they got it wrong,” Shehan said.
But the biggest problem with non-compliance is the fact that the tax rules surrounding digital currencies are still under development and constantly evolving.
The IRS treats virtual currencies like bitcoin as property, which means they are taxed the same way as stocks or real estate. If you buy bitcoin for $ 10,000 and sell it for $ 50,000, you face $ 40,000 in taxable capital gains. Although this concept is relatively simple, it is not always clear what constitutes a “chargeable event”.
Is buying dogecoin with your bitcoin a taxable event? Buy a TV with your dogecoin? Buy an NFT with ether?
All of the above events are technically taxable.
“The government says if I buy something with crypto, it’s like I liquidate my crypto no different than if I sell any other property,” Taub said.
Mining dogecoins for fun is considered self-employment income in the eyes of the government. According to cryptocurrency tax software TaxBit – which recently contracted with the IRS to help the agency with audits related to digital currency – tax rates vary between 10% and 37% on mining products.
“Crypto-miners must pay taxes on the fair market value of coins mined upon receipt,” wrote Justin Woodward, a crypto-taxation lawyer. While there are ways to get creative to minimize this tax burden, like classifying mining as a business and deducting expenses for equipment and electricity, it takes a bit of acrobatic classification to make it work. .
Earning interest on inactive bitcoin in your crypto wallet also counts as income and is taxed as such. Exchanges like Coinbase have also started sending Form 1099-MISC to taxpayers who have earned $ 600 or more in crypto rewards or staking.
IRS crackdown on crypto
Crypto trading volume may have fallen off a cliff in recent weeks, but the overall market value of digital currencies is still up around 75% this year. The IRS made it clear that it wanted to participate in the action.
The agency recently stepped up efforts to subpoena centralized crypto exchanges to obtain information on non-compliant U.S. taxpayers.
This spring, the courts allowed the IRS to issue summons to John Doe to cryptocurrency exchange operators Kraken and Circle to find people who made at least $ 20,000 in cryptocurrency transactions from 2016. to 2020.
The IRS also used this same type of summons in 2016, when it tackled Coinbase crypto transactions from 2013 to 2015.
Issuing these summons one exchange at a time is a clunky way to catch non-compliant U.S. taxpayers, but it can be effective, according to Jon Feldhammer, partner at the Baker Botts law firm and former senior litigator for the IRS.
In 2019, the IRS announced that it was sending letters to more than 10,000 people who potentially failed to report their crypto income.
Rettig said in a statement that taxpayers should take the letter “very seriously in reviewing their tax returns and, if necessary, amending past returns and refunding taxes, interest and penalties.”
According to Shehan, the infamous “Letter 6173” gave individuals 30 days to respond to the IRS or they risked having their tax profile reviewed. Letters were sent again in 2020, and a new round of these stern warnings is expected to be sent this fall.
Even the threat of a letter prompts many to seek advice from accountants on whether they should get ahead of a potential audit and be proactive about changing past statements.
“A lot of people ask me on Twitter, ‘Oh my god, in 2018 I had $ 200 in capital gains that I didn’t report. What should I do?’” Shehan said. “In this case, it’s just not worth the trouble to change the return to get $ 200 in income… The most important thing is that if you didn’t do anything intentionally, you’re fine.”
The IRS is also getting smarter at uncovering crypto tax evaders using new data analysis tools it can use internally.
The agency’s partnership with TaxBit is part of this effort. Taub describes the software as being able to browse cryptocurrency wallets and analyze them to determine what has been bought and sold in crypto. In addition to enlisting the services of the provider itself, Taub says IRS agents are trained in the software to identify tax evaders.
Biden’s new crypto rules
The president’s 2022 budget proposal could lead to a slew of new crypto reporting requirements for those who sell digital coins.
US Treasury Department’s new “Greenbook,” released in May, calls for more comprehensive reporting requirements for crypto, so spending digital currencies unreported is as difficult as spending money today .
A proposal would require companies to report to the IRS all cryptocurrency transactions valued at more than $ 10,000. Another claims that crypto asset exchanges and custodians report data on user accounts that generate at least $ 600 in gross entries or exits in any given year.
Another potential blow to crypto holders: Biden’s proposal to increase the maximum tax rate on long-term capital gains to 43.4%, from 23.8%.
“Crypto gains are taxed like any other type of asset gain, either long-term capital gains or ordinary rates. President Biden has proposed eliminating the difference between the two,” said David Lesperance, a Toronto-based lawyer who specializes in relocating the wealthy.
Lesperance told CNBC that the proposal would also work retroactively and apply to all transactions that took place after April 28, 2020.
“This translates into an increase in capital gains tax of $ 19,800 for every $ 100,000 of crypto capital appreciation,” he said.
Amid the growing crackdown on crypto in the United States, Lesperance has helped clients move abroad in order to completely eliminate their tax burden.
“By exercising a properly executed expatriation strategy, the first capital appreciation of $ 750,000 is tax free and the individual can organize themselves to pay no US taxes in the future,” he said. declared.
But Lesperance warned taxpayers must act quickly. “The track to execute this strategy is very short,” he said.