The IRS Getting Clearer on Crypto Questions

The IRS is determined to find crypto tax evasion.

This year will be over before you know it. Once the calendar year closes and the dust settles, whatever you gained or lost is supposed to get tallied and reported. So sayeth the IRS–and they are so serious about it they give us over three months to get the data together.

Now they are getting serious about another aspect of income: cryptocurrency. 

Crypto has been growing exponentially, but so are people’s crypto tax problems. The IRS is making crypto a top priority. They are making crypto tax changes and making progress in catching tax evaders.


New Instructions for tax form 1040


The IRS wants you to let them know about your crypto activity. You are required to answer the crypto question on your return and must answer under penalty of perjury. The general perjury statute under federal law classifies perjury as a felony and provides a prison sentence of up to five years. However, the consequences of falsely answering the question are up to the IRS’s discretion.


The IRS has released a draft with the updated crypto section in the 2022 instructions for the 1040 individual income tax return. The crypto question on the 2021 return required you to indicate whether you had received, sold, or exchanged in “virtual currency.” The crypto question on the 2022 return has changed “virtual currency” to “digital assets.”


According to the draft instructions, “digital assets are any digital representations of the value recorded on a cryptographically secured distributed ledger or any similar technology.” The IRS said the 1040 crypto instructions include, “For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins.”


Miles Fuller, a former senior counsel with the IRS Office of Chief Counsel, said the change in new terminology is a good sign that the IRS is preparing more guidance. “The IRS is ramping up by coalescing their terminology around this asset term that was in the statute,” he said. “So, it means that it’s more likely than not in the implantation of a regulatory regime. Probably sooner rather than later.”


The final IRS instructions for the crypto section of the 2022 tax return haven’t yet been released, so the crypto section could still be changed before it’s official.


The government is getting serious about crypto


According to government estimates, the difference between taxes owed to the U.S. government and those paid was nearly $600 billion in 2019. The IRS believes that a significant portion of this tax gap is attributable to crypto transactions. Consequently, the IRS has targeted crypto to help reduce the tax gap. Congress passed legislation that will provide the IRS with an additional $80 billion over the next decade. Most of the money will be used for increased enforcement to help the IRS collect unpaid taxes.


President Biden signed an Executive Order (EO) on Ensuring Responsible Development of Digital Assetsthe “crypto order,” earlier in March. Since then, government agencies have worked together to develop policy recommendations related to crypto.

Congress passed a law requiring annual tax reporting from digital currency brokers beginning in 2023. The law may bring in approximately $28 billion over the next ten years, according to an estimate by the congressional Joint Committee on Taxation.


The IRS recently had a big win regarding crypto. A U. S. District Court granted the IRS a “John Doe” summons of M. Y. Safra Bank after investigating SFOX, a digital currency broker. Judge Paul Gardephe stated there was a reasonable basis to believe at least ten people failed to pay tax on crypto transactions, thus enabling further investigation.


The court order should provide information concerning over 175,000 users and over $12 billion in transactions since 2015. This isn’t the first summons for crypto information. However, it’s unusual since the broker is relatively small. This suggests more court orders are coming.


“The government’s ability to obtain third-party information on those failing to report their gains from digital assets remains a critical tool in catching tax cheats,” IRS Commissioner Chuck Rettig said. “The court’s granting of the John Doe summons reinforces our ongoing, significant efforts to ensure that everyone pays their share. Taxpayers earning income from digital asset transactions need to come into compliance with their filing and reporting responsibilities.”


Tax evasion consequences


The IRS announced that it plans to make public criminal tax-evasion cases that involve cryptocurrency. If the IRS decides not to prosecute criminally, you could still receive a 20% accuracy-related penalty and a 75% fraud penalty. It gets worse if the case goes criminal. 


If the IRS prosecutes criminally, you can go to jail if you commit tax evasion or tax fraud. Generally, it’s a maximum five-year prison term and a fine of $100,000 ($500,000 for corporations). The same activity which constitutes criminal tax fraud could be determined to be civil tax fraud. It’s up to the IRS to decide whether it wants to impose criminal tax penalties, civil tax penalties, or both. Just because criminal tax penalties are imposed doesn’t mean the IRS won’t also impose civil tax penalties. In most criminal tax cases, a convicted defendant must pay civil tax, penalties, and criminal fines.


You can avoid evasion consequences


Given these penalties, crypto should always be reported to avoid the wrath of the IRS. It’s crucial to report the income before you are contacted by the IRS regarding the matter. You will need to file a superseding return or an amended return to make a tax return correction.


A superseding return is a second return filed before the due date for the return. A superseding return is treated as if it was the original return for the tax period, eliminating penalties or other action based on missing information. A Qualified Amended Return (QAR) is an amended return filed before the IRS contacts you regarding the matter.


Gains reported on a QAR that was omitted from the original return are excluded from the deficiency calculation on which accuracy-related penalties are based. However, amending the return does not qualify as a QAR when the new amount reported is a correction of a fraudulent position taken on the original tax return.


If you failed to report your cryptocurrency income on your previous tax returns, you should speak with a tax expert with digital currency expertise.

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