The cryptocurrency market has exploded in recent years, with more people buying and selling digital currencies like Bitcoin and Ethereum. While cryptocurrency trading can be very lucrative, it also comes with important tax obligations that traders need to be aware of. One of the most common questions asked by crypto traders is “What happens if I don’t report my crypto transactions on my taxes?”
In short, failing to report capital gains from crypto trading can lead to serious consequences with the IRS. Cryptocurrency transactions are taxable events just like stocks and other investment assets. When you sell or trade crypto and make a profit, you incur a capital gain that must be reported on your tax return. If you don’t properly report these transactions, you could be audited, face tax penalties, or even criminal prosecution for tax evasion in extreme cases.
In this article, we’ll provide an in-depth look at crypto tax reporting rules and explain exactly what happens if you don’t report crypto sales or trades. We’ll also discuss how the IRS tracks crypto transactions and what steps they will take if they detect unreported activity.
Crypto Profits Are Taxable
The first thing to understand is that capital gains made from selling cryptocurrencies are subject to capital gains taxes just like other investment assets. The IRS treats virtual currencies like Bitcoin as property for tax purposes. This means that:
– Selling cryptocurrency at a profit triggers a capital gain
– Using crypto to buy goods and services can trigger a taxable event if the crypto has gained in value since you acquired it
– Trading one crypto for another (e.g. Bitcoin for Ethereum) is a taxable event
– Receiving cryptocurrency from mining, staking rewards, airdrops or forks is taxable income
Anytime you dispose of crypto assets for a profit, it is considered a taxable event by the IRS. Short-term capital gains are taxed at your ordinary income tax rate, while long-term capital gains (for assets held over one year) are usually taxed at more favorable rates, depending on your income.
Cost Basis & Capital Gains
To determine your capital gain or loss when selling crypto, you need to know your cost basis – the amount you paid to acquire the crypto.
Cost basis = Purchase price + Transaction fees
Capital gain/loss = Selling price – Cost basis
Properly tracking cost basis and reporting gains and losses on crypto trades is essential to staying compliant with IRS regulations.
Penalties for Not Reporting Crypto Transactions
So what happens if you fail to report capital gains from crypto trades on your tax return? The consequences can be quite severe. Here are some potential penalties for not reporting crypto transactions:
Tax Audit
One of the most likely outcomes of ignoring crypto gains is getting audited by the IRS. If they detect large unexplained deposits in your bank account or activity on crypto exchanges, they may open an audit to investigate further. A crypto tax audit means providing extensive documentation of all your transactions. It also gives the IRS time to find other issues or discrepancies in your returns. Getting audited can be a lengthy and stressful process.
Tax Bill With Penalties & Interest
If the audit reveals crypto gains you failed to report, you will receive a tax bill from the IRS to pay what you owe. You will have to pay the capital gains tax that was due, plus interest and penalties that have accrued. The failure-to-file penalty is generally 5% per month of the unpaid tax up to 25%. The failure-to-pay penalty is 0.5% per month up to 25%. Interest is currently 6% per year compounded daily. These penalties and interest charges add up quickly, usually to much more than what you originally owed.
Criminal Charges
In extreme cases where very large amounts of income have gone unreported over multiple years, you could potentially face criminal tax evasion charges. This occurs when the IRS believes you knowingly and intentionally attempted to conceal income, rather than just making an oversight. The penalties for tax evasion include fines up to $250,000 and up to 5 years in prison. Most cases of unreported crypto income do not lead to criminal prosecution, but it is possible in aggravated situations.
How the IRS Finds Unreported Crypto Income
If failing to report crypto transactions poses so many risks, how does the IRS catch people who don’t pay taxes? The IRS has begun ramping up efforts to track and audit cryptocurrency traders. Here are some of the ways they can detect unreported transactions:
Exchange Records
One of the easiest ways the IRS identifies crypto tax evaders is through records provided by exchanges. In the U.S., most major cryptocurrency exchanges like Coinbase, Kraken, and Gemini are required to file Form 1099-K if user accounts conduct over $20,000 worth of transactions in a year.
Form 1099-K reports:
– The user’s name and contact information
– Gross transaction amounts throughout the year
By comparing exchange records against amounts reported on tax returns, the IRS can quickly spot where crypto gains may be missing.
Bank Account Deposits
The IRS can also use bank records to identify unexplained cash deposits that may be from crypto trading profits. If your bank accounts show large cash deposits that don’t match other income sources reported on your taxes, it can trigger an audit.
Third-Party Records
Increasingly, the IRS is issuing subpoenas and using software to analyze Third-party records for signs of crypto tax evasion. Third-party data sources include:
– Payment processors like Venmo and PayPal
– Wallet providers like Blockchain.com
– Mining pools
– Staking platforms
– Other parties involved in crypto transactions
By piecing together information from multiple third-parties, the IRS can reconstruct full transaction histories and flows of funds.
Questionable Tax Return Information
Information on your tax return itself can also raise red flags if there are discrepancies suggesting unreported income sources. Significant problems include:
– Declaring income that seems too low for your lifestyle and spending
– High deductions, contributions or suspicious losses possibly used to offset gains
– Prior amended returns used to retroactively claim losses after a profitable year
Anything that suggests you are trying to obfuscate the full scope of your financial activities can trigger an audit. The IRS is getting increasingly savvy at flagging these issues on crypto-related returns.
Strategies to Avoid IRS Penalties
The best way to avoid severe IRS penalties from unreported crypto income is to properly report all crypto capital gains and transactions on your tax return. Here are some tips to help ensure you are compliant with crypto tax rules:
Accurately Track Cost Basis
Calculate cost basis correctly by including fees so you can figure exact gains and losses. Keep detailed records of when and at what value you acquired any crypto.
Record All Transactions
Keep track of every taxable crypto event, including trading, spending, miner rewards, airdrops, staking yields, and more. Transactions across multiple exchanges should be consolidated.
Use Crypto Tax Software
Tax software can automatically import, track, and generate crypto tax reports. This avoids errors and saves huge time compared to manual methods. Popular options include CoinTracking, ZenLedger, CryptoTrader.Tax, and CoinTracker.
Work With a Tax Professional
Consider having a crypto specialized CPA or tax attorney review your transactions before filing taxes. They can help identify any issues and properly prepare documentation if audited.
Take Losses to Offset Gains
If you have losses on crypto trades, use them to lower your capital gains tax burden. Just make sure losses claimed are clearly documented in case of an audit.
File Amended Returns
If you discover previously unreported crypto income, file amended tax returns as soon as possible to avoid further penalties.
Frequently Asked Questions
Does the IRS know if I don’t report crypto?
Yes, the IRS has multiple ways to identify unreported crypto activity as outlined above. But proper reporting gives you the best chance of avoiding an audit.
Can I go to jail for not reporting crypto trades?
You are very unlikely to face jail time unless you are convicted of overt criminal tax evasion. However, failure to report significant crypto income could potentially trigger criminal charges.
Do I have to report if I lost money on crypto?
Yes, losing trades must still be reported. Losses can lower your taxable income, so reporting them is to your advantage.
What if I traded on a decentralized exchange?
Trades on decentralized exchanges like Uniswap are still taxable. You must track and report these even without 1099 forms.
Can I amend a previous return to add crypto?
Yes, you can file an amended return to correct mistakes from prior years. You will still owe any taxes due plus interest and possibly penalties.
The Bottom Line
Cryptocurrency trading generates tax obligations that cannot be ignored without consequences. The IRS is aggressively tracking unreported crypto activity through exchange records, bank data, and other sources. If caught, you may face tax bills with steep penalties and interest, plus drawn out audits. You can avoid these outcomes by accurately reporting all crypto transactions and staying compliant with IRS rules. Recording your crypto activity, working with tax software, and connecting with a crypto-savvy tax professional are key best practices for staying in the good graces of the IRS.