Cryptocurrency Tax Evasion: Separating Fact from Fiction

It’s one of the common attacks you’ll hear on cryptocurrency: the technology is designed for tax evasion and nothing else. 

While the cryptocurrency ecosystem has added millions of new investors in recent years, the space still faces the same tired attacks. In August 2021, the Nobel Prize-winning economist Paul Krugman claimed that ‘…tax evasion and illegal transactions are still the only serious uses of cryptocurrency’. 

While these types of claims are still very common, they aren’t supported by the facts. 

In this guide, we’ll debunk some of the common myths and misconceptions about cryptocurrency and tax evasion. 

Why crypto tax evasion isn’t easy 

Because cryptocurrency transactions are pseudo-anonymous, many people assume that it’s easy to evade taxes. This is a misconception. 

How blockchain transactions can be tracked

While transactions on blockchains like Bitcoin and Ethereum are technically anonymous, they are publicly visible. That means that cracking down on tax fraud is as simple as matching ‘anonymous’ wallets to known individuals. 

Typically, the IRS can identify investors through 1099 forms — which are issued by major exchanges like Coinbase.  

In the past, the IRS has worked with contractors like Chainalysis to analyze blockchain transactions and crack down on crypto tax fraud. 

How the IRS is fighting crypto tax evasion 

As time goes on, the IRS is obtaining more and more resources to fight tax evasion. 

The 2021 Infrastructure Investment and Jobs Act tightens the requirements for crypto exchanges issuing 1099 forms. Soon, the IRS will have information on all cryptocurrency disposals through major exchanges. 

In the future, it’s likely that the IRS will be dedicating more resources to fighting crypto tax evasion. The Inflation Reduction Act of 2022 gives $80 billion of additional funding to the IRS — which includes funds dedicated to stopping cryptocurrency tax crimes. 

Cryptocurrency tax reporting is trending upwards 

A 2018 report by Credit Karma found that just 0.04% of the company’s users were reporting cryptocurrency on their taxes, despite the fact that more than 5% of Americans reported owning cryptocurrency at the time. 

However, it seems that these numbers are trending upwards over time. A 2021 study by CoinLedger found that 54% of investors were reporting cryptocurrency on their tax bills — a huge increase in just three years’ time. 

There are several reasons why reporting cryptocurrency taxes is becoming more and more common over time. 

Why is cryptocurrency tax reporting becoming more common

Lack of knowledge on the cryptocurrency ecosystem

Because cryptocurrency is such a new asset class, many investors aren’t aware how their transactions are taxed. 

The 2021 CoinLedger study found that just 25% of the investors who didn’t report cryptocurrency on their taxes simply didn’t know that crypto was taxable. 

Because cryptocurrency investors tend to be younger, it’s likely that many are simply unaware of the tax consequences of their transactions. It’s only natural that as the cryptocurrency ecosystem matures, investors grow knowledgeable about how virtual assets are taxed. 

Lack of clarity around certain transaction types 

The cryptocurrency ecosystem has moved at a breakneck pace. NFTs and DeFi went from virtually unknown to billion dollar industries in the span of a few short years. 

Today, it’s estimated that there’s more than $50 billion locked in DeFi protocols. However, the IRS has yet to provide guidance on how DeFi loans and adding cryptocurrency to a liquidity pool is taxed. 

While the NFT boom started in 2020, the IRS didn’t provide any clarity about how these virtual assets are taxed until October 2022. 

Unfortunately, this lack of clarity means that it’s difficult for investors to understand how to report certain transactions on their tax returns. 

While the IRS has moved slowly when it comes to cryptocurrency taxes, it’s clear that the agency is paying close attention to the ecosystem. More guidance on cryptocurrency will help eliminate some of the stress and uncertainty that comes with tax reporting. 

Lack of resources on cryptocurrency 

When the crypto ecosystem started booming, investors didn’t have the tools available to track their transactions. 

In 2017, when Bitcoin was going through its first climb to $20,000, crypto tax reporting required hours of time and effort. Investors were often forced to keep detailed spreadsheets that listed all of their buys, sells, and transfers. 

At the time, finding an accountant with a background in cryptocurrency was incredibly difficult. Because crypto was such a new asset class, most tax professionals did not have knowledge about the ecosystem. 

Today, there are far more accountants with expertise in cryptocurrency. As more investors have started to participate in the ecosystem, more tax professionals have started to offer crypto-related services. 

Even investors who can’t afford the help of a tax professional have other resources at their disposal. Today, crypto tax platforms allow investors to automatically import transactions from their blockchains and exchanges and generate a complete tax report in minutes. 

In conclusion 

It’s true that many crypto investors have historically underreported their income. However, as the space has grown more and more mainstream, crypto tax evasion has become less and less common. 

It’s clear that investors are coming to the cryptocurrency ecosystem not to evade taxes — but to build wealth outside the confines of the traditional financial system and experiment with an exciting new technology.