IRS Is Cracking Down On Cryptocurrencies

Posted: Aug 09, 2019 8:34 AM
IRS Is Cracking Down On Cryptocurrencies

Source: AP Photo/Kin Cheung

One of the biggest draws of cryptocurrency for retail investors and enthusiasts alike was the industry’s lack of regulation and its relative freedom from the prying eyes of government. For some time, governments largely acquiesced, proceeding with hesitation and a wait-and-see attitude that best suited everyone. Now, however, it seems the honeymoon is over, with the IRS now in aggressive pursuit of crypto holders.

Recently, the US tax authority sent a letter to over 10,000 crypto holders, warning that they had potentially underreported income and had failed to pay taxes on their cryptocurrency transactions. Unlike offers for voluntary disclosure, those who received the letter will not be entitled to any leniency despite coming forward. They will be required to pay any back taxes along with penalties they have accrued and failure to do so could mean an audit or even prison time and a fine of up to $250,000.

The letter marks a sharp departure from the US government’s previous hands-off stance and signals a potentially tough time ahead for cryptocurrency holders across America. Moving forward, investors will have to be careful about their cryptocurrency reporting. Over the long run, this might be beneficial, adding transparency and greater mainstream integration for the sector.

A Pivotal Time for Crypto

The US Government has had a complex and reluctant relationship with crypto since it first entered the mainstream conversation. The idea of a fully decentralized digital currency—bitcoin’s original promise—meant that its entire infrastructure would be outside the purview of any regulator around the world. As the total market capitalization grew, however, it became difficult for even the government to ignore.

The early period of contact was marked by contradicting statements from US regulators and financial authorities alike. The Commodities Futures Trading Commission, for instance, labels cryptocurrencies as “commodities”, while the SEC dubs them “securities”. Meanwhile, the Treasury Department treats them as currencies, and the IRS designates cryptos as property.

The situation gained some clarity once the US officially recognized cryptos as a taxable asset, dividing it into two brackets, one for short-term gains (holding cryptos for one year or less which is taxed as income) and one for long-term gains (holding cryptos for longer than a year which is treated as capital gains). Later clarifications also helped the situation, with the SEC taking a firmer stance on ICOs and the token launch craze, and clear statements by the agency regarding their classification of most cryptocurrencies as securities.

The IRS moving forward with its plans shows that the industry has reached a pivotal junction in taxation. Governments of the world are actively debating and collaborating on new taxation and regulation systems for the burgeoning industry, and the IRS’ latest missive has arrived at a crucial juncture.

Its proximity to the recently held G20 summit regarding its Financial Action Taskforce (FATF) agreement rules highlights some key aspects. For one, world governments want to bring crypto into the mainstream, and further under their control. This means significantly broadening taxation powers and providing stronger restrictions on the industry. The result is greater oversight on individuals, and a greater tax rate than most investors had grown accustomed to. More importantly, this new trend shows the importance of treating crypto as taxable and avoiding any penalties with some foresight.

As such, the market is already responding with solutions to address the new reporting guidelines. Platforms like Bittax, a tool that helps users calculate and file their crypto taxes by tracking transactions across the blockchain, offer an easier way out. Bittax shoulders the full burden of tax compliance and reporting for cryptocurrency traders and investors using blockchain to trace a user’s entire history of currency activity and providing alerts on incomplete information for retrieval plus addresses that may have been forgotten. 

The Best Interest of Investments and Taxes

The current drive of regulators to rein in the crypto industry stems from the idea that all cryptocurrencies are inherently “dark” or used largely for nefarious purposes. This may have been true before, especially in the infamous  case of Silk Road, but today the industry has shown itself willing to play ball with governments and regulators alike.

“Black” crypto still exists in the form of full decentralized finance (DeFi), with completely deregulated exchanges and crypto-only transactions and trades. On the other hand, “white” crypto includes fiat exchanges like Coinbase (which was allegedly the source of information on the 10,000+ investors the IRS reached out to), legitimate tools for centralized finances, and other regulator-friendly uses.

While many crypto users like to think they belong to the black crypto world, the reality is that at this point, only the original Bitcoin miners and those who have never changed their crypto for fiat are immune to regulators’ investigations. Unfortunately, it seems the tax man has become an integral part of the cryptocurrency ecosystem.

For investors and enthusiasts, this means wising up and being as compliant as possible. This includes keeping track of where transactions were made, when they were made, the coins used, and determining gains and losses. Americans already deal with an archaically complex tax code every year, and the new regulations add more strain to an incredibly stressful time, as well as the real risk of a quarter-million dollar fine. It is vital for consumers and crypto enthusiasts to be wary and prepared, as tax avoidance is taken seriously, and tax fraud could result in jail time, regardless if the currency was digital or not.

The Future of Tokenization 

Cryptocurrency is not going anywhere, with the sector gaining mainstream popularity and acceptance from the traditional financial services industry. As regulators encroach on the field, however, they will have to grapple with a financial sector that does not quite line up with the existing one. Taxes on cryptocurrencies at different levels could mean that paying for a cup of coffee with Bitcoin could result in paying taxes on it twice for different reasons. Even so, as consumers, it is vital to prepare and use whatever tools are necessary to protect themselves from the wrath of the tax man.