Usually, the Internal Revenue Services (IRS) expects its taxpayers to voluntarily report their taxable income for the financial year as per the comprehensive set of tax laws created by the IRS. If a taxpayer fails to report their crypto taxes, they can face hefty penalties, and therefore, it is recommended to proactively and honestly report taxes to the tax authority. Nonetheless, a great number of taxpayers fail to report their crypto transactions, placing them in the reporting gray zone.
Having said that, it must be understood that the taxpayer is not always in the wrong as a few may just not know that they need to report their transactions, and sometimes may simply not know what exactly to report. So, how does the IRS know you owe them crypto taxes? Can the IRS track crypto? The short answer is yes; but how does the IRS track crypto? Read on to find out.
What Makes Crypto Taxable?
In 2014, the tax collection agency announced that they are going to treat cryptocurrency as a property for tax purposes and not as a virtual currency. Even then, only a few taxpayers were filing their crypto transactions; so much so, that during 2013 and 2015, only a few hundred taxpayers reported their crypto transactions.
Thus, in an attempt to impose cryptocurrency tax laws, in 2019, the IRS mailed over 10,000 letters to taxpayers who might have missed the tax filing deadline. Additionally, the tax collection agency added an extra question on Form Schedule 1 directly asking taxpayers if they made crypto transactions in the current financial year.
The question on the form asked the taxpayer whether they—at any point throughout 2019—sold, received, exchanged, sent, or earned interest in cryptocurrency. Later the IRS shifted the question from Form Schedule 1 to Form 1040 used by taxpayers to report their yearly income tax return.
So, How Does the IRS Track Crypto Transactions?
The IRS has wielded many ways to track crypto transactions, allowing the IRS to prosecute the taxpayers if they avoid paying their taxes on their annual crypto income.
One way the IRS can track cryptocurrency is through crypto exchanges or trading platforms. The transactions done on the exchanges/platforms are directly reported to the IRS. If your trading platform provides you with a Form 1099-B or 1099-K, the IRS knows about your crypto transactions. Moreover, if you have over $600 in crypto proceeds, you are going to receive Form 1099-K showing your monthly crypto earnings.
Crypto exchanges are required to send these forms to users who meet the requirements and a copy of the form is then sent to the IRS. While filing your taxes, if you somehow miss to include these amounts, your returns will be automatically flagged by the IRS information processing system for under-reporting. In the same manner, the system will flag you for under-reporting if you don’t report Form 1099-B on your tax returns.
Several exchanges such as Kraken, Coinbase, Gemini, Binance.US, Uphold, and many others report directly to the tax collection agency. Thus, if you receive forms from these exchanges, it is highly possible that the IRS already has its copy and you are liable to report your returns and steer clear from tax penalties.
Subpoenas as a Method to Monitor Crypto
Issuing subpoenas is another method used by the IRS to monitor cryptocurrency transactions. In recent years, Several exchanges have received several subpoenas directing them to reveal some of the user accounts. For instance, Coinbase was asked by the IRS to reveal information of approx. 13,000 accounts including name, taxpayer identification number, address, birth date, transaction logs, account activity records, all account statements or invoices. In the same way, the IRS has ordered other exchanges such as Circle, Kraken, and Bitstamp to release U.S. taxpayer information used on the exchange.
So, can the IRS track crypto with these subpoenas? Yes, the IRS can determine how often the U.S. taxpayers engaged in cryptocurrency transactions and how many of them went unreported. Even though issuing subpoenas to each exchange can be time-consuming, it is a highly effective way to identify non-compliant taxpayers.
To Wrap it Up
The IRS is taking active measures to ensure that every taxpayer is paying what they owe to the tax collection agency. Can the IRS track crypto efficiently? Maybe, but since the agency has ramped up its efforts to impose tax laws in the crypto space, it has also begun consulting with several blockchain companies to remain in the lead. These blockchain companies are helping the IRS with emerging technology such as machine learning, pattern recognition, and data analysis to identify non-compliant taxpayers. Thus, the IRS is all set to become fully equipped with tools that deal with suspicious activities across different exchanges and blockchains.