However, that’s far from reality, the legitimacy of cryptocurrencies has been verified by real-world applications like De-Fi, a massive online financial infrastructure that runs parallel to the physical network of banks and other financial institutions and operates at a similar scale within a decade of inception.
Crypto as an asset is new, and the regulations around it are precarious at best, which leads to a lot of confusion, with crypto taxes leading the conversation from the forefront. And this is one of the biggest reasons why people end up with unintentional tax evasion and tax fraud. A lot of people end up evading taxes because they’re simply unaware of the intricacies of crypto taxes, tax evasion, and the regulations around them.
So here’s a detailed primer on crypto tax evasion. By the time you reach the end of this extract, you’ll know enough about tax evasion to not fall into it unintentionally.
Ok, so let’s set the groundwork for this conversation by answering the most basic question.
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What is crypto tax evasion?
Crypto tax evasion refers to the illegal non-payment or underpayment of taxes on income generated through transactions involving cryptocurrencies.
This can include failing to report income from cryptocurrency trading, mining, or other activities, as well as failing to pay taxes on capital gains from the sale of cryptocurrencies. It is important to note that while it is illegal to evade taxes, it is legal to reduce your tax liability through legitimate means such as tax deductions and credits.
Now, tax evasion may be intentional or unintentional, however, if you’ve bought, sold, traded, or have been gifted crypto in the past and fail to report these transactions in your tax report, the IRS will likely take interest.
Understanding Crypto Tax Evasion
The IRS categorizes crypto tax evasion into two sections:
- Evasion of payment
- Evasion of assessment
Let’s understand them one at a time.
Evasion of payment
Evasion of payment occurs when someone decides to conceal the possession of assets or funds while the tax assessment is being conducted to avoid paying taxes on those assets or funds.
Evasion of Assessment
Evasion of assessment refers to the wilful underreporting of transactions or intentional overstatement of deductions to reduce tax liabilities to the IRS. This is the most common type of crypto tax evasion tactic used by wrong-doers to pay fewer taxes. The IRS is extremely cautious of such tax frauds and has released a comprehensive list of transactions that will be counted as evasion of assessment.
If you have participated in any of the transactions given below, it will be counted as an evasion of assessment by the IRS.
- Failing to report the capital gains from the sale or disposal of cryptocurrency
- Underreporting income from disposal of crypto assets
- Failing to report additional income from crypto assets received as gifts, airdrops, or staking rewards
- Failing to report crypto income from business operations
- Failing to report wages earned in crypto assets
What if you don’t report crypto transactions on your tax returns?
All crypto transactions are traceable because they’ve been recorded on the blockchain, sure they appear as anonymous transactions on the ledger, however, it’s just a matter of correlating those transactions with your wallet address and the KYC details with crypto exchanges(that is already shared with the IRS) to uncover your identity. Now, in case you decide to underreport crypto transactions intentionally or unintentionally, the discrepancies are immediately evident and you end up with trouble.
According to I.R.C §7206, any individual who fails to report their taxable income in their tax report can face fines of up to $100,000 and a maximum sentence of three years in prison. On the other hand, an individual found to be evading taxes could face a fine of $250,000 and up to five years in prison
Why is Crypto Tax Reporting a Challenging Task?
Here are some other reasons why people fail to report their crypto taxes:
Lack of clarity on the nature of crypto transactions
The lack of clarity on these transaction types inadvertently leads to underreporting of transactions and unintentional tax evasion or tax reports as reported by the IRS.
Lack of tools to track transactions
Back when Satoshi Nakamoto facilitated the mining of Bitcoin’s genesis block and the world’s first cryptocurrency was born, nobody had a clue that the crypto space would one day be home to 14,000 different tokens. There were no specialized tools to monitor and track crypto transactions.
Also, crypto was barely regulated, and there were no laws mandating the taxation of such transactions, so people had no incentive to track them. Those who were smart enough to predict the mass adoption of cryptocurrencies as a concept maintained a ledger of these transactions on excel sheets. And these ledgers were as accurate as humans can be.
How the IRS is Fighting Crypto Tax Evasion?
The IRS is fighting crypto tax evasion on multiple fronts:
- It has mandated the use of Form 1099 for all major crypto exchanges in the country, every time an investor fills out form 1099 sent by their respective exchange, the details are reported to the IRS.
- The IRS is consistently adding resources to fight crypto tax evasion in the US. The proposed Inflation Reduction Act of 2022, would allocate an additional $80 billion in funding to the IRS, with a portion of those funds earmarked for preventing tax violations related to cryptocurrency.
- Earlier in 2022, the IRS announced the hiring of 87,000 additional agents for 2023, with a focus on enforcing taxes related to cryptocurrency and reducing tax evasion. These agents will be trained in identifying and matching blockchain transactions to anonymous wallets for the 2023 tax returns
- Jim Lee, the head of the IRS Criminal Investigation Division, confirmed in November 2022 that the agency is in the process of building a significant number of cases related to crypto tax evasion and plans to make them public shortly.
What if you’ve avoided crypto taxes in the past?
If you have failed to pay or report taxes related to cryptocurrency in the past, making a voluntary disclosure to the IRS may help you avoid criminal prosecution. This involves cooperating with the IRS and paying any taxes owed in full. However, it is important to note that this option is only available if the IRS has not already begun an investigation
Frequently Asked Questions(FAQs)
1. What happens if you evade tax?
If you evade taxes in the US, you may face penalties and fines, and in severe cases, criminal charges and imprisonment. The specific consequences depend on the circumstances of the evasion and the amount of taxes owed. It is important to comply with tax laws and file accurate returns to avoid potential legal issues.
2. What is tax fraud?
Tax fraud is the illegal act of intentionally providing false information on a tax return to pay less in taxes or receive a larger refund than is legally owed. Tax fraud can include underreporting income, claiming false deductions or credits, and failing to report all income. Tax fraud is a federal crime in the United States and can result in fines, penalties, and even imprisonment.
3. What is the difference between tax fraud and tax evasion?
Tax fraud and tax evasion are both illegal acts related to taxes, but they involve slightly different behaviors.
- Tax fraud refers to the intentional act of providing false information on a tax return to pay less in taxes or receive a larger refund than is legally owed. Examples of tax fraud include underreporting income, claiming false deductions or credits, and failing to report all income.
- Tax evasion, on the other hand, refers to the illegal non-payment or underpayment of taxes. Tax evasion can include not reporting all income, claiming false deductions or credits, or failing to file a tax return. It can be done by individuals, partnerships, or corporations.
4. Why crypto tax evasion isn’t easy?
Cryptocurrency tax evasion is not easy for several reasons:
- Transparency: Cryptocurrency transactions are recorded on a public ledger, which makes them transparent and traceable.
- Reporting requirements: The IRS and other tax agencies require cryptocurrency exchanges and other service providers to report certain transactions to them.
- Legal requirements: The IRS and other tax agencies have issued guidance on how to report cryptocurrency transactions for tax purposes.
- Increased enforcement: As cryptocurrency becomes more mainstream, tax agencies are paying more attention to it.
- Lack of understanding: Many individuals may not be aware of the tax implications of their cryptocurrency transactions, and may accidentally evade taxes without realizing it.