Cryptocurrency investment and usage has gained significant momentum over the past five years, and the IRS is now cracking down on income tax compliance. With more individuals earning income resulting from the value appreciation of their cryptocurrencies as well as from mining, staking and other rewards earned from participating in various cryptocurrency protocols, government agencies are starting to take closer notice of the industry. The IRS in particular has ramped up its cryptocurrency tax enforcement efforts over the past 12 months.
In my work running a software company specializing in cryptocurrency tax automation, we have had a front-row seat to these regulatory happenings. The recent cryptocurrency tax enforcement efforts from the IRS and what those mean for investors are summarized below.
July 2019: IRS sends out warning and action letters.
The IRS started its crypto tax compliance crusade by sending out over 10,000 letters to cryptocurrency investors suspected of inaccurately reporting their crypto activity (or not reporting at all). Certain versions of these letters were “no-action” letters and simply acted as a warning alerting the recipient that the IRS was aware of their cryptocurrency activity and that they needed to be properly reporting the related income on their tax return. Other versions of these letters were not as relaxed and required action as well as an immediate response from the recipient. We’ve heard from many individuals who received this version of the letter who said they were audited by the IRS for not reporting their cryptocurrency-related income on prior years’ tax returns.
October 2019: IRS releases new revenue ruling on cryptocurrency.
In October, for the first time in over five years, the IRS released new guidance on how digital currencies are to be treated from a tax perspective. Along with this guidance came a lengthy FAQ addressing common questions having to do with cryptocurrency tax reporting. This was an important moment for individual investors and crypto companies alike as the IRS provided further clarity on cryptocurrency forks, air drops and appropriate cost basis methods.
December 2019: IRS releases new 1040 Schedule 1 form requiring all American taxpayers to declare any cryptocurrency activity.
The most meaningful and weighted action taken by the IRS over the past year was the modification of Form Schedule 1 to include a “catch all” question requiring cryptocurrency investors, owners and users to officially affirm or deny their involvement with cryptocurrencies. This question was officially added to the top of Form Schedule 1, which is a form all American taxpayers are required to complete. By making all American taxpayers answer this question, the IRS positioned itself to be able to criminally prosecute those who willingly answered the question untruthfully.
May 2020: IRS solicits private contractors to aid in cryptocurrency tax audits.
Most recently, the IRS released a statement of work and began soliciting private cryptocurrency tax software companies, such as ours, to aid in the audit efforts of individual taxpayers. (Note: Our company will not be pursuing the contract.) This announcement made clear that the IRS has begun investing heavily in resources that will allow it to accurately assess whether individuals are properly reporting their cryptocurrency-related gains, losses and other income on their tax returns. According to the statement of work, the IRS is looking to find instances when “the taxpayer’s data is inconsistent from what would be expected from normal accounting practices.”
What This Means For Crypto Investors
It’s clear the IRS is ramping up cryptocurrency tax enforcement, so what should crypto investors be doing? Of course, the obvious answer is they should be accurately reporting all crypto gains, losses and income with their taxes each year. This is easier said than done, however, as cryptocurrency transaction data is often fragmented across multiple exchanges, wallets and various platforms. To handle this, crypto investors should be keeping careful records of their transactions. Cryptocurrency tax software tools can help with record keeping; however, old-fashioned spreadsheets can also do the trick.
Without doubt, the past year has seen the most action from the IRS in regard to cryptocurrency tax enforcement efforts since the birth of the industry. We will likely see continued efforts from the agency in years to come.