Failure to report crypto transactions correctly can lead to audits, penalties, and collection actions. If you use crypto for anything, you may have tax consequences, and it's critical to understand the IRS's rules about crypto and other digital assets. You must report all of your income on your tax return, including gains from cryptocurrency transactions.
Keep reading so that you know what to expect if you have unreported crypto.
How the IRS Finds Out About Unreported Crypto
The IRS can find out about unreported crypto in a few different ways. Some crypto exchanges issue 1099-B, 1099-misc, or 1099-K forms to sellers, and if so, they will also send a copy to the IRS. The IRS uses special software to look for discrepancies between people's tax returns and information received from other parties.
Over the past few years, the IRS has subpoenaed several exchanges to obtain information about crypto traders. If your details were released, the agency will know that you have unreported crypto. Additionally, when criminal activity is suspected, the agency uses blockchain analytic tools to find the owners of pseudonymous wallets.
Although it's rare, the agency can also use other discrepancies in your return to detect unreported income. For instance, if you file tax returns with income that is substantially lower than usual for your area, the agency may audit your return and try to figure out if you have unreported income. This doesn't just apply to crypto but to any unreported income.
Consequences of Unreported Crypto
If you don't report gains from selling crypto, the IRS can adjust your tax return, assess a tax liability against you, and apply penalties to your account. In some situations, the agency may assess civil fraud penalties or bring criminal charges against you. Here's a deeper look at the potential consequences:
Adjustments to Your Tax Return
If the IRS discovers that you haven't reported crypto gains on your tax return, the agency can adjust your return and send you a tax bill. Here's an example. Say that the IRS receives a 1099-B from a crypto exchange saying that you have $10,000 in taxable crypto gains, but that income is not on your return. Then, the agency may send you a CP2000 or a similar notice letting you know that they have added the gains to your tax return and the amount that you owe.
Substitute for Return
What if you didn't file a return at all? Then, the IRS may issue a substitute for return (SFR). This is a computer-generated return that the IRS creates using information received from other parties. SFRs usually lead to a higher than necessary tax liability because they don't give you any deductions or credits.
Penalties
When you underreport your income, you also underreport your tax liability, and the IRS has several different penalties. In almost all cases, the agency will assess a failure-to-pay penalty. This is between 0.5% and 1% of the unpaid tax. The IRS may backdate this penalty to your return's due date, and it will continue to apply until it maxes out at 25% or you pay the tax in full.
If you substantially understated your income by not reporting the crypto, the IRS may assess an accuracy-related penalty of 20% of the unreported tax. Generally, this applies if you understated your income by 10% or $5,000 (the IRS uses the higher number). Fraud penalties are 75% of the underreported tax.
Audits
If the IRS discovers that you have unreported crypto, the agency may decide to audit some of your older returns. This can happen if the IRS discovers unreported crypto gains through one of the methods listed above, but additionally, if the agency discovers unreported crypto through an audit, it may audit older returns.
Enforced Collections
When unreported crypto leads to a tax liability, the IRS may try to forcefully collect the tax from you. The agency has a lot of power to collect unpaid tax, and it may issue tax liens, garnish your wages, or seize your assets. The IRS can seize real or personal property for unpaid tax, and that includes crypto. In 2022, the agency seized $7 billion in crypto.
How to Deal With Unreported Crypto Gains
To minimize the consequences of unreported crypto, you need to be proactive. If the IRS finds you first, the consequences are almost always worse than if you come forward voluntarily.
There are a few different ways that you can address unreported cryptocurrency. Here are the main options based on your situation:
- If you didn't file a return at all — File a delinquent return to report the income or gains from your cryptocurrency. Then, pay the tax owed plus failure-to-file and late-payment penalties.
- If you filed but forgot to report the crypto — File an amended return to report the crypto-related transactions. This is sometimes called a back door disclosure.
- If you are worried about criminal prosecution — Use the Voluntary Disclosure Program.
Consider consulting with a tax professional to ensure you choose the optimal option for your situation. They will be able to help you plot the next steps forward.
IRS Voluntary Disclosure Program
Voluntary disclosure allows you to come clean about unreported crypto transactions without worrying about criminal charges. You can only use the voluntary disclosure program if the IRS has not contacted you about the unpaid tax. If you're already under audit or investigation, you cannot use this program.
The IRS has two different processes for making a voluntary disclosure. One option is for general disclosures about unreported income, while the other is for cases with possible criminal elements. The agency advises taxpayers to consult with a tax attorney before using either of these options.
To apply for the voluntary disclosure program, start by filling out Part I of Form 14457 (Voluntary Disclosure Practice Preclearance Request and Application). If the IRS grants you pre-approval, you will need to fill out Part II of Form 14457. You can download this form from the link on the IRS's website.
To make a voluntary disclosure, you will need the following:
- Details about all virtual currency transactions for the last six years.
- Information about where the crypto is stored.
- Whether or not you used a mixer or tumbler.
- Why you used a mixer or tumbler.
- Additional details as requested by the examiner assigned to your case.
You will also need to pay all taxes for the last six years, and if tax evasion was involved, you may need to pay a civil fraud penalty of 75% of the highest year's tax liability. If you cannot afford to pay the tax liability in full, you can request a payment plan, but you should be prepared to make a full financial disclosure to the IRS.
In most cases, if you fully adhere to all of the requirements of the voluntary disclosure program, the IRS will not pursue criminal action against you.
What About Crypto Losses?
Generally, if you don't report crypto losses, the IRS isn't going to come after you. The agency typically isn't that concerned when people overpay their tax bills.
However, you can lose money by not reporting crypto losses. You can use losses to offset other capital gains on your return, and if you have more losses than gains, you can offset up to $3,000 in ordinary income with your losses. If you have additional losses, you can roll them forward and claim them against capital gains or up to $3,000 of income in future years.
If you weren't aware of this rule, consider amending your old returns. You only have three years to amend a return to claim a refund, but even if you're past that deadline, you may still want to amend your return so that you can roll the losses forward.
What If I Forgot to Report the Crypto?
The IRS won't accept this as an excuse. Forgetting a tax requirement does not absolve you of your legal obligations. You cannot claim ignorance. When you file your tax return, you must answer a question about cryptocurrency.
If you use tax prep software, the program will ask you the question. Otherwise, your accountant should ask you, or you will see the question when you fill out the paper tax form. This question makes it nearly impossible to say that you didn't know about the reporting requirement.
FAQs About Failure to Report Crypto
The tax laws and requirements related to crypto and other digital assets can be a bit complicated. If you have more questions, you are not alone. Here are answers to frequently asked questions.
What If I Just Own Crypto? Do I Have to Report It?
Generally, if you're simply holding onto crypto, you don't need to report it. However, if the crypto is from a foreign exchange or held in a foreign wallet, the IRS considers it to be a specified foreign asset, and you may need to report it.
If you're a single filer living in the United States, you must file Form 8938 (Statement of Specified Foreign Assets) if your foreign crypto is worth over $50,000 on the last day of the tax year or over $75,000 on any day during the tax year. The threshold is double for a married couple filing jointly, and it's higher if you live outside of the country. This is just an informational return. It will not lead to a tax bill, but if you don't file it, the penalties are severe.
This is one of the only situations where you have to report crypto that you are holding. In most cases, you only need to report crypto when you dispose of it for more than its value when you received it or when you receive crypto as business revenue or as payment for a capital asset.
Do I need to report crypto if I don’t sell?
You should report all crypto dispositions even if you don't sell the crypto. For instance, if you use crypto to buy goods or services, you must report the difference in the crypto's value (from the day you obtained the crypto to the day of the purchase) as a capital gain or loss. Similarly, if you trade crypto for other types of crypto or other digital assets, you must also report the change in value as a gain or loss.
In certain situations, you need to report crypto even if you don't dispose of it. In particular, if you received the crypto in exchange for services or for selling a capital asset, you need to report it. You also need to report crypto that's classified as a specified foreign asset.
For example, say that you own a digital marketing company and you accept cryptocurrency as payment from a client. Then, you must report the crypto's fair market value on the day of receipt as business revenue. Similarly, say that you sold a piece of vacant land for crypto. Then, you must report the capital gain on the sale just as you would if you accepted cash for the land. After that, you don't need to report anything until you dispose of the crypto.
Which Crypto Exchanges Do Not Report to the IRS?
Some exchanges don't issue 1099 forms unless you have a certain volume or value of trades. If the exchange doesn't issue a 1099 form to you, then, it also doesn't issue a 1099 form to the IRS. However, that doesn't mean that you can fly under the radar and not report your gains.
Whether you receive a 1099 form or not, you are still obligated to report crypto gains on your tax returns. Additionally, the IRS can obtain information from the exchanges, whether they issue 1099 forms or not. As the agency has ramped up its efforts to find non-compliant tax filers, it has subpoenaed hundreds of thousands of records from crypto exchanges.
What If I Only Had a Small Gain?
There's no minimum reporting threshold for crypto gains. Even if you only gained a dollar, you are expected to report it. However, that rule also applies to losses. Even if you only lost a bit, you can still use those losses to offset your income.
Get Help With Unreported Crypto
Right now is a terrifying time to have unreported crypto. The IRS is increasing its focus on digital assets. While the agency is paying careful attention to possible criminal activity, it's also looking for general instances of unreported crypto.
This is a relatively new area of the tax code, and to ensure you get the best guidance possible, you should work with a tax pro who has experience with cryptocurrency. Using TaxCure, you can search for local CPAs, enrolled agents, and tax attorneys. Then, you can narrow down the results to find someone who's experienced in crypto. You can also search based on unfiled returns, penalties, audits, or other issues that you are having.
Don't let the IRS come after you for unreported crypto. Don't drown in unnecessary penalties or get stuck dealing with an intensive audit. Instead, get help from a seasoned tax professional today.
