The IRS is Cracking Down on Cryptocurrency Tax Compliance in 2023
Cryptocurrency tax compliance has been a priority for the Internal Revenue Service (IRS) for several years. While the IRS has long held the position that cryptocurrency is a form of “property” for federal income tax purposes, it has failed to provide clear guidance on many cryptocurrency-related issues—including issues related to mining and staking, among others.
At the same time, however, the IRS has insisted that cryptocurrency investors comply with the law. It has aggressively sought out the identities of cryptocurrency investors from exchanges and other third parties, and it has vigorously enforced investors’ reporting and payment obligations. Endowed with new enforcement mechanisms as a result of the 2021 infrastructure bill, we expect to see the IRS crack down even harder on cryptocurrency investors who fail to report their taxable gains in 2023.
New Reporting Requirements Give the IRS Additional Insight Into Cryptocurrency Investors’ Tax Liability
The 2021 infrastructure bill contained a few particularly noteworthy provisions for cryptocurrency investors. These provisions do not alter cryptocurrency investors’ tax obligations, but rather enhance the IRS’s ability to uncover and enforce these obligations through audits and investigations. The following new cryptocurrency reporting obligations are in place for 2023:
- A requirement to report all cryptocurrency transactions with a total value in excess of $10,000 (similar to the existing requirement for financial institutions to report cash transactions in excess of $10,000);
- A requirement to report all transactions that result in assets being transferred away from cryptocurrency exchanges; and,
- A requirement for cryptocurrency “brokers” (a term which remains to be defined) to report cryptocurrency sales (similar to the existing requirement for stockbrokers to report securities transactions).
Notably, it remains to be seen exactly how the U.S. Treasury Department will implement these requirements. While the requirement to report cryptocurrency transactions valued at $10,000 or more is relatively straightforward (and also relatively easy for the IRS to enforce), the others will require greater effort to implement. As a result, whether (and when) they will create affirmative obligations for cryptocurrency investors and companies in 2023 remains to be seen. But, regardless of how long it takes the Treasury Department to implement the new cryptocurrency reporting mandates, U.S. taxpayers must still ensure that they are fully complying with their federal income tax obligations in 2023.
What Do Cryptocurrency Investors Need to Know about Federal Income Tax in 2023?
Given the IRS’s focus on cryptocurrency tax compliance, taxpayers who have invested in Bitcoin, Ethereum, and other digital currencies need to be absolutely certain that they are meeting their federal tax obligations. So, what do investors need to know?
Here are five critical facts for cryptocurrency investors in 2023:
- Selling, trading, and disposing of cryptocurrency are all potentially taxable events. Cryptocurrency investors must report and pay tax on transactions that result in the realization of income from their investments. This includes selling cryptocurrency, exchanging certain types of cryptocurrency for others, and using cryptocurrency to make purchases.
- Cryptocurrency investors have an obligation to report all taxable transactions to the IRS. Even if these transactions number in the hundreds or thousands, U.S. taxpayers have an obligation to disclose their income from (and pay tax on) all reportable events.
- Cryptocurrency transactions can trigger ordinary or capital gains tax liability. Similar to securities transactions, cryptocurrency transactions can trigger either ordinary or capital gains tax liability depending on how long the relevant tokens are held. Currently, use of the “highest in, first out” (or “HIFO”) accounting method is still permitted.
- The IRS is using third-party sources to confirm taxpayers’ cryptocurrency-related obligations. Over the past few years, the IRS has used “John Doe” summonses and various other investigative tools to obtain cryptocurrency investors’ identities from exchanges and other third parties.
- U.S. taxpayers cannot expect to hide their cryptocurrency transactions from the IRS. In light of existing reporting obligations, the new reporting obligations established under the 2021 infrastructure bill, and the IRS’s investigative tools, U.S. taxpayers cannot expect to hide their cryptocurrency transactions going forward.
What Should Cryptocurrency Investors Do if They Are Behind On Their Federal Income Tax Obligations?
Reporting all relevant transactions and paying all taxes due is the best way for cryptocurrency investors to avoid unwanted IRS scrutiny. But, what should cryptocurrency investors do if they are already behind?
For cryptocurrency investors who are behind on their federal income tax obligations, coming into compliance before the IRS initiates an audit or investigation is imperative. Once an audit or investigation is underway, the most-favorable options go off of the table. For taxpayers who are not yet facing IRS scrutiny, options for coming into compliance may include (and are not necessarily limited to):
1. Filing an Amended Return
In some cases, cryptocurrency investors will be able to address delinquent filings by submitting an amended return (along with any back taxes, interest, and penalties owed). However, as a point of clarification, taxpayers should not shoehorn previous years’ cryptocurrency transactions into their 2023 returns. This is referred to as making a “quiet disclosure,” and it is a form of federal tax fraud.
2. Seeking an Offer in Compromise
The IRS’s offer in compromise program provides a way for taxpayers to settle their delinquent tax liability—including delinquent tax liability related to cryptocurrency income. While not all taxpayers qualify, those who do can reduce their outstanding liability while also eliminating any concern of a future audit or investigation related to the settled debt.
3. Making a Voluntary Disclosure
Voluntary disclosure is an option for cryptocurrency investors who are at risk for facing criminal prosecution due to willful income tax filing violations. Similar to the IRS’s offer in compromise program, eligibility for making a voluntary disclosure is limited—although the eligibility criteria here are very different. Submitting a voluntary disclosure can be risky, and anyone who is considering a voluntary disclosure in relation to their cryptocurrency tax debt should consult with a lawyer first.
What are the Penalties for Failing to Report (or Pay Tax on) Cryptocurrency Income?
Failure to report or pay tax on cryptocurrency income can be prosecuted as a civil or criminal offense depending on the circumstances involved. The primary factor triggering criminal culpability in most (but not all) cases is willfulness, or intent.
When prosecuted as a criminal offense, cryptocurrency-related tax evasion is a federal felony. Individuals can face up to a $100,000 fine and five years in prison for each individual violation. Businesses can face fines of up to $500,000 per violation.
Cryptocurrency Investors Need to Prioritize Federal Tax Compliance in 2023
Just how serious is the IRS about combatting cryptocurrency-related tax fraud? In 2021, 93 percent of all seizures executed by IRS Criminal Investigations (IRS CI) involved cryptocurrency. Additionally, as IRS CI disclosed in its 2021 Annual Report:
“Over the last few years, CI has prioritized training and the deployment of cryptocurrency, blockchain and open-source intelligence (OSINT) technologies to unravel complex cyber-financial criminal schemes. To ensure CI’s capabilities continue to evolve with the online and digital payment landscape, CI plans to launch an Advanced Collaboration & Data Center (ACDC) in the Northern Virginia area in 2023. The focus of the center will be to bring together data, technology, and specialized personnel from across Treasury and government to work on high impact solutions to protect the integrity of our tax and financial systems.”
In short, the IRS is paying close attention to the cryptocurrency sphere in 2023—and it won’t be shifting its focus away any time soon. As a result, cryptocurrency investors need to prioritize federal tax compliance, and those that face scrutiny from the IRS or IRS CI need to be prepared to defend themselves by all means available. Cryptocurrency investors who have concerns about what they may owe the IRS should:
- Download their cryptocurrency transaction histories. To assess their federal income tax liability, cryptocurrency investors must assess their gain or loss from each individual transaction. Even if this is an arduous and painstaking process, it is absolutely necessary.
- Collect their federal income tax records. Cryptocurrency investors who are behind (or who may be behind) on their federal income taxes should collect their returns from all relevant years to review with their tax professional or attorney.
- Avoid making any assumptions. The federal tax laws and regulations governing cryptocurrency are complicated. As a result, investors need to avoid making any assumptions—positive or negative—about what they may owe the IRS.
- Consult with a federal tax fraud defense lawyer. Given the risks involved in failing to report cryptocurrency tax liability to the IRS, investors who have concerns about their liability should consult with an experienced federal tax fraud defense lawyer promptly.
Speak with a Federal Tax Fraud Defense Lawyer at Oberheiden P.C.
The federal tax fraud defense lawyers at Oberheiden P.C. represent individual and corporate taxpayers nationwide with regard to cryptocurrency tax compliance. If you have questions or concerns about your (or your company’s) obligations to the IRS, we encourage you to call 888-680-1745 or get in touch with us online to arrange a complimentary consultation.
Dr. Nick Oberheiden, founder of Oberheiden P.C., focuses his litigation practice on white-collar criminal defense, government investigations, SEC & FCPA enforcement, and commercial litigation.