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IRS Pursues First Criminal Case for Underreporting Crypto Gains

IRS Pursues First Criminal Case for Underreporting Crypto Gains

It's no secret that the IRS is cracking down on the crypto industry. Until recently, these efforts have focused on sending taxpayer notices and clarifying tax regulations. A new case marks a more aggressive stance.

It’s no secret the IRS is cracking down on the crypto industry.

The agency believes that three-quarters of taxpayers holding crypto could be misrepresenting these assets on their tax returns and paying less than they owe.

But, until recently, these efforts have focused on subpoenaing crypto exchanges, sending taxpayer notices, and clarifying tax regulations.

The indictment of a Texas man accused of underreporting crypto gains marks an aggressive change in the IRS’ strategy to collect its due taxes.

In this article, we’ll take a closer look at the case and what it means for the future of crypto tax enforcement. Then, we’ll discuss how you can protect yourself from the crackdown.

What Happened?

A federal grand jury indicted a Texas man on charges of filing false tax returns and structuring cash deposits to avoid cryptocurrency reporting requirements. This instance is the first criminal case for cryptocurrency capital gains not reported to the Internal Revenue Service (IRS).

According to the indictment, Frank Richard Ahlgren III filed false tax returns that underreported or failed to report the sale of $4 million of bitcoin between 2017 and 2019.

In 2017, he filed a false tax return that inflated the price he originally paid for Bitcoin and used the proceeds to purchase a $3.7 million home. Then, in 2018 and 2019, he failed to report bitcoin sales worth more than $650,000. He also made several bank deposits of less than $10,000 to avoid triggering currency transaction reporting requirements.

Ahlgren faces a maximum penalty of five years in prison for each structuring count and three years for each false return count. A federal district court judge will sentence the man after considering sentencing guidelines and any statutory factors.

Part of a Trend

Over the past few years, the IRS has taken several steps to crack down on crypto tax evaders and close a big part of the tax gap.

The Inflation Reduction Act gave the IRS about $80 billion to increase enforcement efforts and close the tax gap. With more than six times its current funding, the agency is hiring 87,000 new agents and devoting $45 billion to enforcement efforts. Of course, these efforts could translate to more audits and collections.

The IRS published new proposed regulations on tax reporting requirements for crypto brokers in mid-2023. These regulations would help identify taxpayers who don’t report their crypto holdings. While these rules are still pending, the agency continues to use John Doe summons on crypto brokers to gain information about taxpayers transacting large amounts.

Earlier this year, the agency recruited former Binance.US and ConsenSys executives to bolster its enforcement efforts in the digital asset space. Sulolit “Raj” Mukherjee previously worked as Global Head of Tax at ConsenSys, while Seth Wilks was VP of Government Relations at the crypto tax software firm TaxBit. And both could help increase the IRS’ crypto capabilities.

Ultimately, all signs indicate more crypto enforcement actions over the coming year. But instead of just more audits and penalties, Mr. Ahlgren’s criminal prosecution suggests that the agency could take an even more aggressive approach to send a message.

How to Protect Yourself

The most obvious way to protect yourself from the IRS’ wrath is paying the taxes you owe – but it’s not always that black and white.

How Do You Accurately Calculate Crypto Taxes?

Calculating your crypto tax can be complicated. For example, if you use decentralized finance (DeFi) protocols, the structure of rewards might determine whether the income you receive is taxed as ordinary income or capital gains. You may also need to aggregate transactions across multiple protocols and exchanges to compute cost basis accurately.

How Do You Accurately Calculate Crypto Taxes?
ZenLedger makes it easy to import transactions from hundreds of protocols and exchanges. Source: ZenLedger

Crypto tax software, like ZenLedger, can help automate the process. Our platform automatically aggregates transactions across protocols and exchanges, computes your capital gains and losses, and generates the paperwork you need to file. We also provide a grand unified accounting spreadsheet to help you in the event of an audit.

What If You Didn’t Report Previous Gains?

If the IRS is correct, three-quarters of taxpayers may be in a situation where they have previous crypto gains they didn’t report. And, if that’s you, you might wonder if you should report those previous gains and if you’ll get in trouble for doing so.

The good news is that the IRS offers a path forward. If you forget to report past income or gains, you can file an amended return and make any necessary payments. While you may pay a penalty for underreporting your taxes, the agency is known to be more lenient to those who make a good-faith effort to pay their taxes properly.

On the other hand, if you willfully neglect to pay the amount and the IRS finds out, they could add civil and criminal penalties to the amount you owe. Since crypto transactions occur on a blockchain and there’s no statute of limitations for fraudulent omissions, there may be a clear record of transactions that lead to these discoveries years after they occur.

What If You Can’t Afford to Pay Your Tax Bill?

Suppose you have a capital gain that you don’t want to report because you cannot afford to pay it. Should you ignore it on your filing and maybe add it later?

You should always accurately file your taxes even if you cannot pay. While you might incur a failure to pay a penalty, you will avoid the higher failure to file a penalty and any separate penalties related to errors and omissions.

The IRS also offers payment plans if you cannot afford to pay a lump sum. If you need up to 180 days, you can request a short-term payment plan with no fees beyond applicable penalties and accrued interest. If you need more time, you can request an installment agreement by completing Form 9465 or calling the IRS.

What If the Tax Doesn’t Seem Fair?

Imagine you receive an airdrop that’s worth $1,000 when you receive it in December 2023. Unfortunately, while you’re gone on vacation, its value plummets to pennies before you get back in January 2024.

In this scenario, the IRS considers the $1,000 ordinary income you’ll have to pay for the 2023 tax year. While you could write off the loss in 2024, it may not seem fair that you owe taxes on money you don’t have anymore.

While these scenarios may not seem fair, you’ll likely have to pay taxes on them, regardless. You can argue for an Offer in Compromise (OIC) if the amount due is substantial, but the acceptance rate may be under 20%, making a compromise very unlikely.

The Bottom Line

The IRS’ indictment of a Texas man for underreporting crypto gains suggests that the agency is becoming more aggressive in targeting taxpayers who willfully ignore their tax obligations.

While the $4 million case isn’t necessarily a warning shot for most of us with sub-seven-figure accounts, it’s still a good idea to come clean if you have any unpaid capital gains from the past and be sure that you’re accurately accounting for your crypto transactions in the present.

ZenLedger can help you stay organized for tax time. We automatically aggregate transactions, compute capital gains and losses, and generate the paperwork you need. Through our partnership with April, you can even complete your entire tax return in one place!

Get started today for free!

The above is for general info purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.

Justin Kuepper