Trading and Investing

IRS Keeps Up Pressure On Crypto Investors Taxes

Published
November 2, 2020
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    The IRS issued a summons demanding that Coinbase produce a wide range of records relating to its customers in December 2016. After a legal battle, the crypto exchange turned over the records of 13,000 customers that rarely reported taxable gains. The move underscored the extent of tax evasion in crypto and prompted the IRS to take an increasingly hostile stance.

    Let’s take a look at how the IRS has targeted crypto traders and crypto investors' taxes in the past and evidence that it’s stepping up efforts in 2021 and beyond.

    IRS Crypto Warning Letters & Changes

    The IRS sent over 10,000 letters to crypto investors' taxes suspected of improperly reporting or failing to report transactions in July 2019. Around the same time of the following year, the agency sent thousands of more letters reminding taxpayers of their obligation to report crypto transactions or requiring them to submit additional information to avoid an audit.

    Crypto Investors IRS
    Sample of IRS Warning Letter - Source: IRS

    There are three types of letters:

    Letter 6173

    Letter 6173 requires taxpayers to file delinquent returns, correct past returns, or demonstrate compliance in a signed statement with a due date.

    Letter 6174

    Letter 6174 informs taxpayers of the requirements for reporting virtual currency transactions but doesn’t make any direct accusations of misconduct.

    Letter 6174-A

    Letter 6174-A suggests that taxpayers may have not properly recorded transactions and requests that any necessary updates be made to account for them.

    The new round of letters come after the IRS released updated guidance in October 2019 that elaborated on the tax treatment of forks, airdrops, and other ambiguous cases. In addition, the IRS posted a lengthy list of frequently asked questions for taxpayers and accountants to better understand its rules and regulations surrounding crypto markets.

    In December 2019, the IRS introduced Schedule 1 to Form 1040, which requires all taxpayers to declare any crypto activity. The new question makes it possible for the IRS to criminally prosecute anyone who willingly answered the question untruthfully. In other words, it has become a lot more difficult to claim ignorance in failing to account for the transactions.

    Gearing Up for Crypto Tax Enforcement

    The IRS began hiring outside contractors in 2020 to help identify crypto traders and investors whose tax returns either omit or contain inaccurate transactions. In a letter sent to some crypto tax experts, the agency said that it is placing a few single-case contracts as pilots with the goal of publishing a solicitation and request for a proposal for a large multi-case contract.

    In particular, contractors would work off of public on-chain data and private off-chain data to try and determine if taxpayers underreported their crypto gains. These efforts mark a significant expansion from the warning letters that the agency has been sending to taxpayers thus far and the limited number of audits seen in the community.

    How To Avoid The Problems Of Crypto Investors' Taxes?

    You can avoid problems with the IRS by ensuring that you accurately record crypto transactions. While it can be challenging to reconcile transactions across wallets and exchanges by hand, crypto tax software can streamline and automate the process. It’s the easiest way to ensure that everything is accurate each year and you have a defensible paper trail in place.

     crypto investors taxes
    ZenLedger’s Pre-filled Tax Forms - Source: ZenLedger

    For example, ZenLedger makes it easy to aggregate transactions across wallets and exchanges, compute capital gains or losses, and auto-populate tax forms for your accountant. In addition, you can use the tax-loss harvesting tool to identify opportunities to reduce your tax bill throughout the month by selling losing positions to realize the loss and offset other income.

    There are a few things to keep in mind when choosing a crypto tax solution:

    Audit Trail

    The crypto tax software should provide a transparent audit trail that you can use in the event of an audit in order to prove that you accurately recorded transactions.

    Complex Transactions

    DeFi, staking, margin trading, and other complex transactions may not be possible with every crypto tax solution.

    Integrations

    TurboTax or other software users may want to consider crypto tax options that integrate with their tax prep solutions to simplify tax season.

    Tax-Loss Harvesting

    The best solutions enable you to save money on crypto investors' taxes via tax-loss harvesting rather than just helping you pay the right amount of taxes.

    If you have unrecorded transactions, you may need to file a delinquent or amended tax return for prior years. These actions may trigger a tax liability in the current year but leaving taxes unpaid could result in a much larger future liability. The statute of limitations doesn’t apply for fraudulent transactions (e.g. intentionally not reporting transactions).

    ZenLedger offers a full-service solution for crypto traders and investors that want hands-on help from an experienced accountant. 

    The Bottom Line

    The IRS has gradually stepped up its enforcement efforts on tax consequences over the past five years. While warning letters have been common over the past two years, there are signs that the agency is gearing up to enforce tax laws in 2020 and 2021 with the solicitation of private contractors experienced with blockchain analysis.

    If you want to ensure your taxes are accurate, ZenLedger can help you quickly aggregate transactions, compute gains and losses, and even pre-fill popular IRS forms to make it as easy as possible for you and your accountant.

    FAQs

    1. Do you pay taxes on Crypto trades?

    If you're buying and selling cryptocurrencies, you'll have to pay capital gains taxes on the profits. Short-term capital gain is taxable as per the slab rates applicable to a taxpayer. And long-term capital gain is taxed at the flat rate of 20% with the benefit of indexation.

    2. How do I avoid capital gains tax on Crypto?

    An easy way to defer or eliminate tax on your cryptocurrency investments is to buy inside of an IRA, 401-k, defined benefit, or other retirement plans. If you buy cryptocurrency inside of a traditional IRA, you'll defer tax on the gains until you begin to take distributions.

    3. Do you have to report Crypto on taxes?

    The IRS has considered cryptocurrency as property, and not currency. Taxpayers are required to report transactions involving virtual currency like US dollars on their tax returns. This means that they must determine its fair market value as of the transaction date.

    4. Do you pay taxes on crypto if you don't sell?

    Even if you don't receive any tax forms, the IRS requires you to report your cryptocurrency gains or losses.

    ZenLedger easily calculates your crypto taxes and also finds opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!

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