The IRS is intensifying its hunt for people who don’t pay taxes on their cryptocurrency gains. Although people are becoming more aware that cryptocurrency gains and losses are taxed as capital gains and losses, the IRS fears that many millions of transactions may be going untaxed.
If you have been buying, selling, mining or using cryptocurrency, you should be aware that most transactions are taxable as capital gains or losses.
What is the risk?
There are serious penalties for failing to report your cryptocurrency gains, especially if the IRS comes to believe you were intentionally evading taxes. Tax evasion carries a penalty of up to five years in prison and a fine of up to $250,000, plus the taxes you owe.
Last year, the IRS sent letters out to 10,000 crypto taxpayers warning them of the consequences for failing to report cryptocurrency gains. If you received such a letter, you could be especially vulnerable to prosecution for tax evasion because it will be less likely you can say you made an innocent mistake.
Moreover, the IRS’s draft 2019 Form 1040 had a checkbox on Schedule 1 requiring you to answer whether you sold, exchanged, sent or otherwise acquired financial interest in cryptocurrency. Failing to check this box, if appropriate, could be seen as evidence of willfulness. Evidence of willfulness makes it much more likely you will face a substantial penalty or be charged with tax evasion.
The IRS is actively working on cryptocurrency taxation. For example, the agency recently moved a top person from the IRS Criminal Investigation Division to head up the Small Business/Self-Employed Division. And, the IRS commissioner has made moves to increase criminal investigations, according to Forbes.
It’s crucial to keep good records
Even if you never receive a W-2 or Form 1099 related to your cryptocurrency transaction, you must still determine the basis of each transaction amount, which means how much the fair market value was of the cryptocurrency at the time you obtained it. Then, you can determine what you gained or lost on each transaction.
This could be tricky if you mined cryptocurrency or received it in a peer-to-peer transaction. You are expected to use some reasonable method to determine the accurate value of the currency in order to use that as a basis for your gains or losses.
You may be able to use online programs to help you estimate the base value of your cryptocurrency. Ideally, you are keeping a detailed log of your transactions for tax purposes. Make your best effort to determine a reasonable method of valuation and use it consistently.