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Why The IRS Isn’t Messing Around This Year

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When you start your taxes, you’ll immediately notice a big change this year. For the first time ever, the IRS has put cryptocurrency front and center. 

I mean literally front and center – right at the top of good ol’ Form 1040. 

 Crypto Crackdown: Why The IRS Isn't Messing Around This Year - Form 1040

They want to know about your crypto trading even before your dependent status, which is like the IRS’s favorite question. 

So why the renewed focus? Is there a crackdown happening this year? How much are your crypto gains being taxed? What exactly do you have to report, and what will happen if you don’t? 

Let’s investigate the Great Crypto Crackdown. 

Why is the IRS finally cracking down on crypto this year? 

 Crypto Crackdown: Why The IRS Isn't Messing Around This Year - Why is the IRS finally cracking down on crypto this year?

The IRS’s crackdown isn’t meant to be a sudden surprise attack like prohibition agents busting up a speakeasy. Rather, the IRS is like a tired campus security officer breaking up a loud house party after giving seven warnings. 

Indeed, crypto has been taxable since 2014. So in the IRS’s eyes, there are simply no excuses left to keep bumping bass music at 3:15 am. They’re coming in the front door, and everyone still inside the house is getting a citation. 

Let’s look at why the IRS is finally out of patience this year, and why they’re not to be trifled with. 

The IRS made crypto taxable in 2014

In 2008, Satoshi Nakamoto created Bitcoin to be a safe and convenient way to exchange currency online without the need for a third party. It wasn’t really intended to be an investment asset, so the IRS didn’t pay much mind. 

However, by 2013 it had become abundantly clear that people were making money off of Bitcoin and would continue to do so. Crypto traders were buying low, selling high, and profiting – some by the millions. 

In the eyes of the IRS, this activity qualified crypto to be a capital asset, not a currency. And when you profit from the buying, selling, and trading of capital assets, you always owe Uncle Sam a cut. Whether it’s stocks, condos, or crypto, you should owe the IRS a capital gains tax on the sale price. 

So in 2014, the IRS published Notice 2014-21. It’s remarkably short and easy to read, and flexes the IRS’s clear understanding of crypto and even how “mining” works. The TL;DR of the notice is that crypto is now taxable, with instructions on how to report it. 

After publishing Notice 2014-21, The IRS probably relaxed in their chairs and waited for the new cash to start flowing in. Some people will miss the memo, sure, but at least we’ll get this gravy train rollin’. 

But even they were probably surprised by what happened next. 

…but nobody cared or paid attention

In the following tax year, Coinbase reached a peak of six million users buying, selling, and trading cryptocurrency. 

But according to Forbes, out of six million users, only a few hundred reported crypto gains on their taxes.  

Granted, not every Coinbase trader would’ve had a taxable event that year, like being paid in crypto or selling some for cash. But the IRS still had a hard time believing that 99.99992% of American crypto traders were HODLing the line, gripping onto their crypto for long-term gains. 

So in 2016, the IRS went after Coinbase

After receiving virtually zero tax revenue from crypto users, the IRS went after Coinbase – the de facto host of the loud house party. 

That’s when things got messy. Here’s a paraphrased recap of key events starting in November of 2016:

  1. The IRS issues a “John Doe” summons to Coinbase demanding the release of all records related to Bitcoin transactions conducted on the platform between 2013 and 2015. The purpose, of course, is to go after tax dodgers. 
  2. Attorney Jeffrey Berns steps in to stop them.
  3. The IRS says “dude, are you kidding? You’re a Coinbase customer – you really can’t talk.”
  4. Berns agrees and backs off.
  5. The IRS files a new motion, reminding Coinbase that they’re sheltering tax dodgers, don’t test us, we brought down Al Capone.
  6. Coinbase agrees to hand over taxpayer IDs, names, birth dates, addresses, and transaction records for all users who traded in volumes higher than $20,000 between 2013 and 2015.
  7. Coinbase publicly warns all 14,000 of those users that the IRS is coming for them.
  8. The IRS issues Letter 6173, warning these high-volume traders to either pay up or lawyer up because an audit is coming their way

Now, if you’re thinking you’re too small of a fish for the IRS to fry, think again. Because what happened in 2020 should have every crypto tax dodger shaking in their boots. 

In 2020, the IRS fired a final, threatening warning shot to traders

In August of 2020, after the 2019 tax season winded down, the IRS fired out a new batch of 10,000 warning letters to crypto traders. 

These were Letters 6174 and 6174-A, and this time around there were two noticeable changes over Letter 6173. 

First, the new letters were way more threatening. They less-than-subtly reminded crypto traders that:

“if you do not accurately report your virtual currency transactions, you may be subject to future civil and criminal enforcement activity.”

Second, in contrast to the fuzzy language of Letter 6173, these letters made abundantly clear that crypto traders owed back taxes on every year they failed to report their capital gains, going as far back as 2014. If they needed to submit multiple amended returns, so be it. 

Lastly, and most concerning to anyone withholding crypto taxes, nobody’s quite sure where the IRS’s list came from. “We don’t know for sure where the IRS got the user list,” reported Cointracker co-founder Chandan Lodha to Bitcoin.com

He goes on to speculate that the new list could’ve come from Coinbase again, but it’s more likely that the IRS built their own list from scratch by leveraging new tracking technology from sources like  Chainalysis, Coinbase analytics, and Palantir. 

Now, the IRS is using blockchain technology to track crypto activity

Let’s go all the way back to 2008 once again. The father of Bitcoin, Satoshi Nakamoto, designs his creation to be safe, convenient, and transparent. 

According to Bitcoin.org:

“Bitcoin works with an unprecedented level of transparency that most people are not used to dealing with. All Bitcoin transactions are public, traceable, and permanently stored in the Bitcoin network.” 

For years, many traders considered Bitcoin to be a tax haven. Technically speaking it was before 2014, but not for the reasons they thought. 

Bitcoin isn’t hidden; the IRS just wasn’t looking yet. 

“Bitcoin addresses cannot remain fully anonymous. As the blockchain is permanent, it’s important to note that something not traceable currently may become trivial to trace in the future.”

Trivial indeed. Every single crypto transaction gets logged in the blockchain, so with the right tools, the IRS can audit anyone’s entire trading history in mere seconds. Crypto isn’t untraceable – it’s the single most traceable currency in the world. 

“Imagine if every dollar in your wallet had a list of everyone who’s ever held it – that’s cryptocurrency” says David Hunter, CFA, Director of Research and Investments at Consolidated Planning Corporation. 

So when traders in the Coinbase forums publicly and openly admitted to using crypto as an illegal tax haven, the IRS said “hold my beer.” 

So what’s new on my 2020 tax returns? 

 Crypto Crackdown: Why The IRS Isn't Messing Around This Year - So what's new on my 2020 tax return?

Technically speaking, there’s nothing really new on the 2020 tax forms except the big question on Form 1040. The very first thing the IRS wants you to do on your for is just admit that you’ve been trading crypto. They already know the answer – they just want to see if you’re honest. 

Interestingly, if your only crypto activity was buying some with cash, the IRS wants you to answer “no” to this question. This has caused taxpayers a lot of confusion since the question asks if you “acquired financial interest” which sounds like buying would qualify. 

But here it is, straight from the IRS’s FAQ on crypto reporting:

 Crypto Crackdown: Why The IRS Isn't Messing Around This Year - IRS's crypto FAQs

To expand, here’s a complete list of crypto-related activity that you don’t need to report:

  1. Buying crypto with cash and holding it.
  2. Donating crypto to a qualified tax-exempt charity or non-profit.
  3. Transferring crypto between wallets.

The following, however, are taxable events and need to be reported: 

  1. Selling crypto for cash (even if you lost money on your initial investment).
  2. Using crypto to pay for goods or services (buying a pizza or a Tesla Model 3, etc.).
  3. Exchanging one crypto for another (i.e. swapping BTC for ETH).
  4. Crypto earned from mining.
  5. Being paid in crypto or by airdrop.
  6. Receiving crypto as a bonus or a reward.

How much will the IRS tax my crypto gains?

The IRS will subject your crypto earnings to the exact same capital gains taxes that apply to other capital assets (stocks, real estate, etc.).

If you held onto your crypto for longer than a year before selling it, you’ll be subject to long-term capital gains taxes: 

Filing status 0% tax 15% tax 20% tax
Single Income under $40,000 Between $40,000 and $441,450 $441,450 or more
Head of household Income under $53,600 Between $53,600 and $469,050 $469,050 or more
Married, separate filing Income under $40,000 Between $40,000 and $248,300 $248,300 or more
Married, joint filing Income under $80,000 Between $80,000 and $496,600 $496,600 or more

What happens if I report my crypto gains inaccurately, or don’t report them at all? 

If you don’t report your crypto gains on your taxes, you can expect to receive a threatening nastygram from the IRS. The agency has clearly developed a system for tracking crypto trading without having to subpoena the big exchanges, and they’ve demonstrated their willingness and ability to use it. 

It’s safe to assume that Letters 6173, 6174, and 6174-A were the IRS’s final warning shots. Back in their original 2016 subpoena of Coinbase, the IRS expressed frustration that billions of tax dollars were unaccounted for in the crypto community. Since then, they’ve had five years to develop tools and trackers to get it back. It’s best not to put yourself in the IRS’s sights, and just pay your 15%. 

If you accidentally misfile, the story may be different… but don’t count on it

If you misfile your crypto on your taxes, that might be a different story. Don’t quote me on this, but it’s *possible* that the IRS will be somewhat forgiving just this once. They’ve already fielded tons of questions about accurately filing crypto capital gains, and even they seem to realize that the process is somewhat complicated. Currently, their FAQ page on the topic is 46 questions long and counting

That being said; however, it’s entirely possible that due to blockchain technology, the IRS already knows exactly how much you owe on your crypto, down to the penny. I’ve had my tax returns rejected by the IRS because my previous year’s AGI was off by a dollar. 

One. Dollar. 

That’s what makes me nervous for my fellow crypto traders. If the IRS is unflinchingly strict about your previous year’s AGI, how will they feel about crypto capital gains? After all, if they allow every crypto trader to miscalculate their capital gains by just a dollar, well, that’s over $10 million in lost tax revenue. 

What does the future hold for crypto regulations and taxation? 

 Crypto Crackdown: Why The IRS Isn't Messing Around This Year - What does the future hold for crypto regulations and taxation? 

In a 1789 letter to a friend, Benjamin Franklin once wrote: 

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”

You can bet your bottom dollar that the IRS will tax cryptocurrency in perpetuity. The only reason they’d stop is if they chose to reclassify crypto as currency, not property. But for that to happen, crypto would have to settle on a valuation, even losing value due to inflation. 

Regs and taxation aren’t such a bad thing

Yeah, I know giving up 15% of your crypto tendies sucks. But at the risk of sounding like a socialist, the IRS collecting more tax revenue isn’t all bad. 

The billions our country will collect in crypto taxes can go to revitalizing our infrastructure, reforming our education system, and most pertinently for young people like us, replenishing social security reserves before we retire

Plus, the government’s increasing role in crypto makes it a safer playground for everyone. In 2012 the FBI busted up Silk Road, a crazy sketchy dark web site trading in Bitcoin, and in 2018 the feds defended traders from John McAfee’s pump-and-dump scheme

In a way, the IRS’s taxation of crypto is actually a win for the crypto community. It shows that the government understands it and won’t outright ban it, nor will it tax it at an unfair rate. Being able to keep 85% of your Bitcoin gains isn’t all that bad. 

Summary

The IRS is now cracking down on crypto, and they’re seemingly done issuing warnings. 

When crypto first became taxable in 2014, fewer than 0.00008% of traders actually paid taxes. With billions in missing tax revenue, the agency that caught Al Capone has subpoenaed the crypto exchanges, developed blockchain-based tracking tools, and fired increasingly close warning shots over the crypto community every year since 2017. 

The IRS’s crypto crackdown may feel like the end of an era, but increased regulation and taxes aren’t such a bad thing. While other countries are prosecuting crypto traders, the U.S. government has taken actions to protect crypto traders from fraud and illegal activity. Plus, the IRS’s newfound billions in tax revenues can help build roads, revitalize infrastructure, and replete social security. 

Indeed, the IRS has put cryptocurrency front and center.

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