For years, US taxpayers’ cryptocurrency holdings have existed in a kind of reporting gray area. But now these crypto wallets are getting a lot of attention from the Internal Revenue Service and President Biden, who seem determined to crack down on tax evaders.
The timing makes sense.
The president has to raise money relatively quickly for his own ambitious economic agenda. And the “tax gap,” which is the difference between taxes paid and taxes owed, is a large pool of cash ready to be harvested. IRS chief Charles Rettig says the country loses about a trillion dollars in unpaid taxes every year, and he attributes this growing tax gap, at least in part, to the rise of the crypto market.
The federal government is so confident of the potential for arrears tax revenue that the White House plans to give the IRS an additional $ 80 billion and new powers to crack down on tax evaders, including those who park their money in cryptocurrencies.
“The IRS is involved in collecting revenue,” said Shehan Chandrasekera, CPA and head of tax strategy at CoinTracker.io, a crypto tax software company.
“Historically, they make $ 5 if they spend $ 1 on any type of enforcement activity … I think the crypto-enforcement activity is even higher,” he said.
Failure made easy
It is easy to be an unintentional crypto tax evader in the US.
For one, the IRS didn’t exactly make it easy to report this information.
The 2019 tax year was the first time the IRS explicitly asked taxpayers if they had traded crypto. One question on the Appendix 1 form was, “At any point in 2019, did you receive, sell, send, barter, or otherwise acquire any financial interest in any virtual currency?”
However, experts said the question is vague, and most importantly, not everyone is submitting this specific document. An Appendix 1 is typically used to report income that is not listed on Form 1040, such as capital gains, alimony, or gambling winnings.
In 2020 the IRS improved its game by moving the virtual currency issue to the 1040 itself, which is used by anyone filing an annual income tax return.
“[They put it] right after your name and social security number and before entering any income or deduction numbers, “said Lewis Taub, accountant and tax director at Berkowitz Pollack Brant, making the question virtually impossible.
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But perhaps the bigger problem, according to Shehan, is that many filers have no idea how to calculate their crypto capital gains and losses.
When trading through a broker, you will usually receive a Form 1099-B listing your transaction proceeds, which streamlines the reporting process.
That doesn’t happen in the crypto world, Shehan said. “Many crypto exchanges do not report information to the IRS.”
While some crypto exchanges have begun issuing a tax form known as 1099-K – which is traditionally given to an individual who makes at least 200 transactions totaling $ 20,000 or more – this form only reports those in relation to crypto Total value of transactions. The total value does not take into account how much the person paid for the cryptocurrency in the first place, which is known as the “cost base”, which makes it difficult to calculate taxable profit.
“A lot of people actually over-declared their income because they were confused,” Shehan said.
The biggest problem for non-compliance, however, is the fact that the tax rules for digital currencies are still being worked out and are constantly changing.
The IRS treats virtual currencies like Bitcoin as property, which means they are taxed similarly to stocks or real estate. If you buy a bitcoin for $ 10,000 and sell it for $ 50,000, you face $ 40,000 in taxable capital gains. While this concept is relatively simple, it is not always clear what a “chargeable event” is.
Is buying Dogecoin with your Bitcoin a taxable event? Buy a television with your Dogecoin? Buy an NFT with Ether?
All of the above events are technically taxable events.
“The government says if I buy something with crypto, it’s like I don’t liquidate my crypto any other way than if I sold any other property,” Taub said.
Mining Dogecoin for fun is considered self-employed income in the eyes of the government. According to cryptocurrency tax software TaxBit – which recently signed a contract with the IRS to assist the agency with audits related to digital currency – tax rates vary between 10% and 37% on mining proceeds.
“Crypto miners must pay taxes on the fair market value of the mined coins at the time they are received,” wrote crypto tax attorney Justin Woodward. While there are ways to get creative to minimize this tax burden, such as: For example, classifying mining as a business and deducting equipment and electricity costs, but it takes a little timeliness to make it work.
Earning interest on the bitcoin that rests in your crypto wallet also counts as income and is taxed as such. Exchanges like Coinbase have also started sending the Form 1099-MISC to taxpayers who have made $ 600 or more from crypto rewards or staking.
The IRS crypto crackdown
Crypto trading volume may have fallen off a cliff in the past few weeks, but the overall market value of digital currencies is still up about 75% this year. The IRS has made it clear that it wants to be part of the action.
The agency recently stepped up its efforts to subpoena centralized crypto exchanges for information about non-compliant US taxpayers.
This spring, courts authorized the IRS to issue John Doe subpoenas to crypto exchange operators Kraken and Circle to find individuals who had completed cryptocurrency transactions worth at least $ 20,000 from 2016 to 2020.
The IRS also used this type of subpoena in 2016 when it came to Coinbase crypto transactions from 2013 to 2015.
Issuing these subpoenas is a cumbersome way to capture non-compliant U.S. taxpayers, but it can be effective, according to Jon Feldhammer, associate at Baker Botts law firm and former senior litigator for the IRS.
In 2019, the IRS announced that it was sending letters to more than 10,000 people who may not have reported crypto income.
Rettig said in a statement that taxpayers should “take the letter very seriously by reviewing their tax returns and, if necessary, changing past tax returns and paying back taxes, interest and penalties”.
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According to Shehan, the infamous “Letter 6173” gave individuals 30 days to reply to the IRS, otherwise they risked their tax profile review. Letters went out again in 2020, and a new round of these serious warnings is expected to be sent out this fall.
Even the threat of a letter causes many people to seek the advice of an accountant as to whether they should anticipate a possible audit and be proactive in changing past returns.
“A lot of people ask me on Twitter, ‘Oh my god, I had $ 200 capital gains in 2018 that I didn’t report. What should I do? ‘”Says Shehan. “In this case, it’s just not worth changing the rate of return to generate $ 200 worth of revenue … The most important thing is, if you haven’t done anything on purpose, you’re fine.”
The IRS is also getting smarter when it comes to detecting crypto tax evaders with the help of new data analysis tools that it can use internally.
The agency’s partnership with TaxBit is part of this effort. Taub describes the software as being able to search cryptocurrency wallets and analyze them to find out what was bought and sold in crypto. In addition to using the seller’s own services, Taub says IRS agents are trained in the software to identify tax evaders.
Biden’s new crypto rules
The President’s budget proposal for 2022 could lead to a number of new crypto reporting requirements for those who trade digital coins.
The Treasury Department’s new Green Book released in May calls for more comprehensive reporting requirements for crypto, making it just as difficult to spend digital currencies without being reported as it is to spend cash today.
One proposal would require companies to report all cryptocurrency transactions worth more than $ 10,000 to the IRS. Another requires that crypto asset exchanges and custodians report data on user accounts that are performing gross inflows or outflows worth at least $ 600 in any given year.
Another potential blow to crypto holders: Biden’s proposal to raise the top tax rate on long-term capital gains from 23.8% to 43.4%.
“Crypto gains are taxed like any other type of capital gain, either long-term capital gains or ordinary rates. President Biden has proposed eliminating the difference between the two,” said David Lesperance, a Toronto-based attorney who specializes in the Resettlement of the rich.
Lesperance informed CNBC that the proposal would also work retrospectively and would apply to all transactions that occurred after April 28, 2020.
“This equates to an increased capital gains tax of $ 19,800 for every $ 100,000 capital appreciation of crypto,” he said.
In the midst of the rampant crackdown on cryptocurrencies here in the US, Lesperance has helped its customers emigrate to reduce their tax burden entirely.
“With a properly executed expatriation strategy, the first $ 750,000 in capital appreciation is tax-free and the individual can organize themselves to avoid paying US tax at all in the future,” he said.
But Lesperance warned that taxpayers need to act quickly. “The runway to implement this strategy is very short,” he said.