Over the past 12 months, the tax collecting agency of the United States has been heavily increasing its enforcement of cryptocurrency related tax compliance. As crypto has risen in popularity over the last few years, tax reporting has not. The IRS enforcement efforts are a direct effort to increase the tax compliance in this emerging industry.
In this guide we discuss how the IRS has been cracking down and what you should be aware of as a participant in the crypto ecosystem.
July 2019 - Warning and Action Letters
In July of 2019, the IRS began sending out thousands of warning and action letters to individuals suspected of misreporting, or not reporting their cryptocurrency income on their prior year tax returns.
It is suspected that these letters were sent out to early Coinbase customers whose information was received by the IRS after the agency subpoenaed the San Francisco-based cryptocurrency exchange.
“On February 23rd, 2018, Coinbase notified a group of approximately 13,000 customers concerning a summons from the IRS regarding their Coinbase accounts.
The court ordered Coinbase to provide taxpayer ID, name, birth date, address, and historical transaction records for certain higher-transacting customers during the 2013-2015 period.”
Some of these letters sent out to Coinbase users who were suspected to be non-compliant were just informational—explaining how cryptocurrency is taxed and how one should be filing taxes. Others were more aggressive stating that the IRS suspects that you did not report your cryptocurrency income. Finally the last of the bunch (Letter 6173) were action letters requiring those who received one to respond or else become subject to an IRS audit.
This was the beginning of the IRS’ crusade to increase crypto tax enforcement. More than 10,000 of these letters were sent out.
October 2019 - Virtual Currency Tax Guidance
After the sending of the letters, the IRS released an update to their virtual currency guidance for the first time in five years this past October. Included in this update was a 45 question FAQ article that can be found here. This FAQ clarified a number of gray areas around fork events, appropriate cost basis methods for cryptocurrency, and what is and is not classified as a taxable event.
In addition to this FAQ, a new Revenue Ruling was also released. The rev ruling discusses the tax implications of hard forks and airdrops and seeks to clarify these areas of crypto. For more information on the specific tax implications of cryptocurrency, see this crypto tax guide.
December 2019 - Updated 1040 Schedule 1 is Released
One of the most significant actions taken by the IRS this past year to increase crypto tax enforcement was the question that the agency added to 1040 Schedule 1, which is a form that every American taxpayer has to fill out as a part of their overall tax return.
On the top of Schedule 1, the new question reads:
“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
Under penalty of perjury, over 150 million Americans are now required to answer this question.
By requiring taxpayers to officially check “yes” or “no”, the IRS is no longer allowing crypto holders to “unknowingly” leave out their crypto income on their return. Those who check “no” who do indeed have crypto holdings can face criminal charges for intentionally misrepresenting themselves on their tax return.
May 2020 - IRS Solicits Contractors to Assist In Crypto Tax Audits
Finally, in May of 2020 the IRS started soliciting the help of private contractors, specifically cryptocurrency tax software companies, to help with the audits of cryptocurrency-related tax returns.
Just like many consumers and retail crypto investors, the IRS needs special software to confirm that individuals are properly reporting their cryptocurrency on their taxes. In order to obtain the specialized software needed they sent out emails to the top cryptocurrency tax software companies soliciting help.
The private contract is likely a lucrative one, and the entire Statement of Work that the IRS sent out to these private companies can be found here.
This action shows that the agency is starting to get very serious about confirming the fact that individuals are paying the right amount in taxes from their crypto related income.
Given the actions of the IRS over the past 12 months, it’s clear that the agency has their sites set on cracking down on cryptocurrency non-compliance. If you are looking to avoid an IRS audit, make sure you are properly reporting your income across all of your crypto transactions.