In March of this year, the IRS’s Office of Fraud Enforcement announced the kickoff of “Operation Hidden Treasure”—a program staffed by a dedicated team of IRS investigators trained in cryptocurrency and virtual currency tracking and focused on identifying taxpayers who have omitted cryptocurrency earnings from their tax returns.
Thus far, much of the new cryptocurrency tax evasion detection effort has been aimed at getting ahead of potential evaders by focusing on what are termed “tax evasion signatures”—signs that a taxpayer may be attempting to game the system. Such signatures include:
- Structuring transactions in smaller amounts (under $10k) to avoid specific reporting requirements,
- Use of surrogates, such as shell corporations and nominees to conceal cryptocurrency gains, and
- Strategic Use of off-chain transactions to reduce fees or conceal one’s identity.
According to its architects, Operation Hidden Treasure has the chief goal of finding and attributing accurate tax liability to those who made gains dealing in cryptocurrencies. One strategy being used by investigators is de-anonymizing crypto transactions to unmask bad actors and identify those with an outstanding tax obligation.
What is Cryptocurrency and are New Cryptocurrencies Being Created?
Basically cryptocurrency is a digital storehouse of value and a means of exchange, much like actual currency. The difference is that cryptocurrency’s value resides entirely in the digital world—without the need for physical bills, tokens, coins, or government oversight. Crypto (or virtual) currency uses block-chain technology to record and verify all transactions. Popular forms of virtual currency include Bitcoin, Etherium, Litecoin, Cardano and Polkadot. Keep in mind that new cryptocurrencies are being created on a regular if not daily basis, leading to a fast growing and ever-changing marketplace.
How Is Crypto Taxed?
The current method of taxing cryptocurrency is based on a 2014 IRS ruling that determined cryptocurrency be treated like stocks or bonds, i.e., more like property than money. When you earn money through a cryptocurrency transaction, you are subject to capital gains on any profit.
For example, if you bought $50 in Bitcoin and through investment saw a gain in value to $500, you’d be liable for a tax obligation on the $450 gain you earned.
The Example of Bitcoin
While Bitcoin is far from the only type of cryptocurrency out there, it is among the longest standing forms of cryptocurrency. Bitcoin is interesting because it is a convertible virtual currency because it has a value in real currency. Transactions performed using Bitcoin are therefore open to the same types of tax liability as other investment earnings.
When Bitcoin is used to purchase goods or services it is treated as taxable income. For example, an employer who paid workers in Bitcoin would be required to report employee earnings to the IRS using a W-2. If you are an employer who pays in Bitcoin, careful record-keeping is essential. Values must be converted to U.S. dollars. Note that wages paid in Bitcoin are subject to the same withholding requirements as payments made in real currency. Both employers and freelance (1099) workers are required to convert Bitcoin earnings into U.S. dollars for tax reporting purposes.
As capital assets, gains made via Bitcoin transactions must be reported in the same way that capital gains and losses accrued by stocks or bonds are reported, with gains subject to the same capital gains tax laws as real currency transactions.
For those who “mine” Bitcoin, all earnings from this process must be declared as income, based on the market value of the cryptocurrency on the day it was received. For the self-employed Bitcoin miner, their gross earnings (minus allowed deductions) is subject to all self-employment tax regulations.
Do You Owe Tax on Virtual Currency Gains?
One quick way to check whether you have a cryptocurrency tax obligation is to ask yourself some basic questions:
- Have you sold any cryptocurrency at a profit during the past year?
- Do you “mine” cryptocurrency?
- Did you receive cryptocurrency as a reward, bonus, or “airdrop”?
- Do you accept payments for goods or services in cryptocurrency?
- Do you convert crypto for yourself or others?
Achieving Cryptocurrency Compliance
The current state of cryptocurrency taxation can be confusing, so if you’ve engaged in virtual currency transactions over the past tax year, it may be advisable to work with a tax consultant who is experienced in virtual currency transactions, and their attendant tax laws.
If you have substantial cryptocurrency gains that remain unreported in your tax filings, now is the time to get these matters in order. Reporting your crypto earnings now, rather than waiting for the IRS’s new cryptocurrency tax evasion agents to find you—can save you a world of fees, penalties, and headaches. The time to act is now—before the IRS launches a tax audit or criminal tax investigation. Often accounts that are out of compliance can be brought back into compliance, saving the taxpayer unnecessary fees and penalties.
At Moskowitz LLP, we understand how confusing tax laws can be. That’s why our team of experienced tax attorneys is here to help. No matter what your tax problem, large or small—we have the knowledge and experience you need. Discover what peace of mind feels like. Contact us today!