All You Need To Know About The Term - Crypto Tax Evasion

The term “Tax evasion” has been repeatedly associated with cryptocurrencies, the allegations going as far as to claim that tax evasion and money laundering are the only genuine use cases of cryptocurrencies.

However, that’s far from reality, the legitimacy of cryptocurrencies has been verified by real-world applications like DeFi, a massive online financial infrastructure that runs parallel to the physical network of banks and other financial institutions and operates at a similar scale within a decade of inception.

Crypto as an asset is new, and the regulations around it are precarious at best, which leads to a lot of confusion, with crypto taxes leading the conversation from the forefront. And this is one of the biggest reasons why people end up with unintentional tax evasion and tax fraud. A lot of people end up evading taxes because they’re simply unaware of the intricacies of crypto taxes, tax evasion, and the regulations around them. 

So here’s a detailed primer on crypto tax evasion. By the time you reach the end of this extract, you’ll know enough about tax evasion to not fall into it unintentionally. 

Ok, so let’s set the groundwork for this conversation by answering the most basic question.

What is crypto tax evasion?

Crypto tax evasion refers to the illegal non-payment or underpayment of taxes on income generated through transactions involving cryptocurrencies. 

This can include failing to report income from cryptocurrency trading, mining, or other activities, as well as failing to pay taxes on capital gains from the sale of cryptocurrencies. It is important to note that while it is illegal to evade taxes, it is legal to reduce your tax liability through legitimate means such as tax deductions and credits.

Now, tax evasion may be intentional or unintentional, however, if you’ve bought, sold, traded, or have been gifted crypto in the past and fail to report these transactions in your tax report, the IRS will likely take interest.

Understanding Crypto Tax Evasion

The IRS categorizes crypto tax evasion into two sections:

1. Evasion of payment
2. Evasion of assessment

Let’s understand them one at a time.

Evasion of payment

Evasion of payment occurs when someone decides to conceal the possession of assets or funds while the tax assessment is being conducted to avoid paying taxes on those assets or funds. 

However, this kind of fraud is barely seen in the crypto space because it’s nearly impossible to conceal assets from the IRS after implementing the Form-1099 issued by crypto exchanges to report all customer transactions to authorities.

Evasion of Assessment

Evasion of assessment refers to the wilful underreporting of transactions or intentional overstatement of deductions to reduce tax liabilities to the IRS. This is the most common type of crypto tax evasion tactic used by wrong-doers to pay fewer taxes. The IRS is extremely cautious of such tax frauds and has released a comprehensive list of transactions that will be counted as evasion of assessment. 

If you have participated in any of the transactions given below, it will be counted as an evasion of assessment by the IRS.

• Failing to report the capital gains from the sale or disposal of cryptocurrency
• Underreporting income from disposal of crypto assets
• Failing to report additional income from crypto assets received as gifts, airdrops, or staking rewards
• Failing to report crypto income from business operations
• Failing to report wages earned in crypto assets

What if you don’t report crypto transactions on your tax returns?

All crypto transactions are traceable because they’ve been recorded on the blockchain, sure they appear as anonymous transactions on the ledger, however, it’s just a matter of correlating those transactions with your wallet address and the KYC details with crypto exchanges(that is already shared with the IRS) to uncover your identity. Now, in case you decide to underreport crypto transactions intentionally or unintentionally, the discrepancies are immediately evident and you end up with trouble.

According to I.R.C §7206, any individual who fails to report their taxable income in their tax report can face fines of up to $100,000 and a maximum sentence of three years in prison. On the other hand, an individual found to be evading taxes could face a fine of $250,000 and up to five years in prison

Why is Crypto Tax Reporting a Challenging Task?

According to a study conducted by CoinLedger in 2021, 25% of the investors who didn’t report cryptocurrency on their taxes simply weren’t aware that crypto was taxable. Now, this is an important statistic to uncover the fact that a huge majority of people who end up under the lens of the IRS for tax evasion, simply lack awareness. Partly, because a majority of crypto investors are young and unaware of the tax obligations that crypto transactions entail. 

Here are some other reasons why people fail to report their crypto taxes:

Lack of clarity on the nature of crypto transactions

The expansion of the crypto-verse was rapid, the pace was so magnificent that neither regulators nor investors could keep up with it. Crypto verticals like DeFi grew to a multi-billion dollar market within a few years. With over $41 billion worth of assets locked in DeFi as of December 2022, the IRS is yet to offer clarity on the taxation of DeFi transactions in the US.

The lack of clarity on these transaction types inadvertently leads to underreporting of transactions and unintentional tax evasion or tax reports as reported by the IRS.

NFT transactions were in a similar space up until November 2022, when the IRS added instructions on how NFT transactions will be taxed under the “digital assets” section of the new tax filing guide released on December 19, 2022.

Lack of tools to track transactions

Back when Satoshi Nakamoto facilitated the mining of Bitcoin’s genesis block and the world’s first cryptocurrency was born, nobody had a clue that the crypto space would one day be home to 14,000 different tokens. There were no specialized tools to monitor and track crypto transactions.

Also, crypto was barely regulated, and there were no laws mandating the taxation of such transactions, so people had no incentive to track them. Those who were smart enough to predict the mass adoption of cryptocurrencies as a concept maintained a ledger of these transactions on excel sheets. And these ledgers were as accurate as humans can be. 

Thankfully, the world has accepted the legitimacy of crypto as a concept and the tools have transformed to accommodate the requirements of investors. Modern crypto tax software like Kryptos can create legally compliant tax reports within seconds based on your location, by auto-fetching your transaction details from all your wallets and exchanges. All you need to do is add your wallets and exchange profiles on the website and you’re done.

How the IRS is Fighting Crypto Tax Evasion?

The IRS is fighting crypto tax evasion on multiple fronts:

1. It has mandated the use of Form 1099 for all major crypto exchanges in the country, every time an investor fills out form 1099 sent by their respective exchange, the details are reported to the IRS.
2. The IRS is consistently adding resources to fight crypto tax evasion in the US. The proposed Inflation Reduction Act of 2022, would allocate an additional $80 billion in funding to the IRS, with a portion of those funds earmarked for preventing tax violations related to cryptocurrency.
3. Earlier in 2022, the IRS announced the hiring of 87,000 additional agents for 2023, with a focus on enforcing taxes related to cryptocurrency and reducing tax evasion. These agents will be trained in identifying and matching blockchain transactions to anonymous wallets for the 2023 tax returns
4. Jim Lee, the head of the IRS Criminal Investigation Division, confirmed in November 2022 that the agency is in the process of building a significant number of cases related to crypto tax evasion and plans to make them public shortly.

What if you’ve avoided crypto taxes in the past?

If you’ve unintentionally avoided crypto taxes in the past, don’t worry it can still be fixed. Use tax software to make a list of all unreported or forgotten transactions and then use Form 1040X to amend your tax report. You should hear from the IRS within 8-12 weeks of returning your form to the IRS.

Alternatively, if you’ve been formally notified by the IRS under tax evasion laws, you can use Form 14457 called the Voluntary Disclosure Practice Preclearance Request and Application which allows people to report previously unreported transactions to the IRS, even if they are facing criminal prosecution for violating tax laws.

If you have failed to pay or report taxes related to cryptocurrency in the past, making a voluntary disclosure to the IRS may help you avoid criminal prosecution. This involves cooperating with the IRS and paying any taxes owed in full. However, it is important to note that this option is only available if the IRS has not already begun an investigation.

FAQs

1. What happens if you evade tax?

If you evade taxes in the US, you may face penalties and fines, and in severe cases, criminal charges and imprisonment. The specific consequences depend on the circumstances of the evasion and the amount of taxes owed. It is important to comply with tax laws and file accurate returns to avoid potential legal issues.

2. What is tax fraud?

Tax fraud is the illegal act of intentionally providing false information on a tax return to pay less in taxes or receive a larger refund than is legally owed. Tax fraud can include underreporting income, claiming false deductions or credits, and failing to report all income. Tax fraud is a federal crime in the United States and can result in fines, penalties, and even imprisonment.

3. What is the difference between tax fraud and tax evasion?

Tax fraud and tax evasion are both illegal acts related to taxes, but they involve slightly different behaviors.

• Tax fraud refers to the intentional act of providing false information on a tax return to pay less in taxes or receive a larger refund than is legally owed. Examples of tax fraud include underreporting income, claiming false deductions or credits, and failing to report all income.
• Tax evasion, on the other hand, refers to the illegal non-payment or underpayment of taxes. Tax evasion can include not reporting all income, claiming false deductions or credits, or failing to file a tax return. It can be done by individuals, partnerships, or corporations.

4. Why crypto tax evasion isn’t easy?

Cryptocurrency tax evasion is not easy for several reasons:

• Transparency: Cryptocurrency transactions are recorded on a public ledger, which makes them transparent and traceable.
• Reporting requirements: The IRS and other tax agencies require cryptocurrency exchanges and other service providers to report certain transactions to them. 
• Legal requirements: The IRS and other tax agencies have issued guidance on how to report cryptocurrency transactions for tax purposes. 
• Increased enforcement: As cryptocurrency becomes more mainstream, tax agencies are paying more attention to it.
• Lack of understanding: Many individuals may not be aware of the tax implications of their cryptocurrency transactions, and may accidentally evade taxes without realizing it.

All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!

About the author

Payam Masood

Head of Content and Social Media - Kryptos