How The IRS Knows You've Traded Crypto

Background

One of the key ideas behind crypto is privacy, the decentralized nature of the space means you can keep your trades private. Yes, your wallet address is public on the blockchain but this string of numbers and letters cannot be used to identify the individual behind the funds.

The more crypto goes up the more the IRS wants to know everything about your crypto trading because the more you make the more they make. As the laws around specific crypto trades develop the more complicated the tax process becomes for you.

The question still remains, how does the IRS know whether you’ve traded crypto at all? If the idea was for privacy for users how come one of the largest government entities in the world knows you owe them money?

Timeline

Back in 2014, the US government declared all forms of digital currency as property, meaning when it was sold it was subject to tax. Over the years these laws have developed substantially but this was the initial signal to crypto traders and investors that even though cryptocurrency was devised as a replacement for government currency the government was still interested in making some money from it.

Records indicate that the IRS has been collaborating with blockchain technology companies 2015, placing an order for work in August 2015 with Chainalysis.

In December 2016 the IRS issued a summons to Coinbase asking for records of over 500,000 customers that had traded crypto over the past few years. The initial stipulation was that Coinbase had to provide any user details if that had a single transaction - deposit or withdrawal larger than $20,000.

The information they had to provide was:

• Taxpayer ID number

• Name

• Birthdate

• Address

• Transaction logs

• Periodic accounts statements

With this information, it’s pretty clear that the IRS would be able to identify who owed them money and even how much in most cases.

More recently crypto exchanges must issue 1099-K and 1099-B forms if you have more than $20,000 in proceeds and 200 or more transactions on an exchange the exchange needs to submit that information to the IRS. So if you’ve received one of these tax forms the IRS definitely knows about at least some of your crypto trades.

Starting in the 2020 tax season, on schedule 1 every taxpayer has to answer a crypto-specific question - if at any time during the year you have received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency. This is a broad question that you would have to answer yes to if you have touched crypto in any form, even if you just held bitcoin the IRS want to monitor this for future years when you do sell.

Crypto taxes are a voluntary system, you are supposed to volunteer information about your trades and how much you owe. However, the IRS has identified cryptocurrency as one five problem areas where taxpayers could evade taxes and have begun criminal proceedings against tax avoiders. If you receive a letter from them stating you are under investigation you are generally no longer eligible to voluntarily declare back-taxes and face potentially reduced penalties.

What about mixers and tumblers?

This is an interesting question as people believe mixing their crypto can protect their privacy and even help them dodge taxes. The bad news is that it isn’t just you that knows about it. The IRS knows about mixers and if anything it will only slow them down. They will still be able to figure out how much you owe.

What if I get audited?

The IRS has started auditing taxpayers specifically to evaluate their crypto trades. This is nothing to worry about and you are expected to disclose any addresses or wallets you own or control and any exchange accounts you have.

On top of this, you have to provide some information about each individual transaction, this is where things can get a little trickier if transactions include token to token trades.

You need to provide:

• “The date and time each unit of virtual currency was acquired,”

• “The basis and FMV of each unit at the time of the acquisition,”

• “The date and time each unit was sold, exchanged, or otherwise disposed of,”

• “The FMV of each unit at the time of sale, exchange, or disposition, and the amount of money or the FMV of property received for each unit.”

• “Explanation of the method used to compute basis relating to the sale or other disposition of virtual currency.”

This is where software like Crypto Tax Calculator can help, keeping track of all this information, and especially in dollar terms can be a difficult process for 10 transactions let alone 100 or 1000. Crypto Tax Calculator automates this process for you and goes one step further and calculates the exact taxes you owe on all your trades.

Conclusion

So the short answer to the question, does the IRS know about your crypto? Is yes. If they don’t, the risk is simply too high that they will eventually find out so it’s better to report the taxes now. If you’re being audited this is also not something to worry about, using a tax calculator can help provide the exact information the IRS needs or if you are especially worried you can hire a crypto accountant to help you navigate the process.