Jim Lee, the head of the IRS’ Criminal Investigation division, recently said that the IRS is building hundreds of crypto cases to be publicly released soon. Reportedly, the focus is going to be “off ramping” transactions and non-reported crypto related income for services rendered. So, this begs the question, should you be worried?
Well, that boils down to a few simple questions:
(1) Did you report your crypto related profit on your taxes last year?
(2) Does the IRS actually have the man power and expertise to successfully scour the blockchain to determine tax fraud? and
(3) Are you going to be unlucky enough to have been selected as an audit guinea pig?
Simple questions, yes, but each (outside of the last one) has a little nuance to unpack here.
Did you report your crypto related profit on your taxes last year?
This may seem like a yes or no question, but the reality is most people will probably say “kind of” or “I tried to”. If you’re as deep in the weeds as most people on CT are, you probably executed hundreds to tens of thousands of transactions last year. The painful reality is that there is no great crypto tax software out there yet. Koinly, CoinTracker, etc., are decent enough, but when you’re hawking Cardano NFTs at 2 AM just to swap those proceeds into AVAX, to then bridge into Cosmos, to then get fleeced by JEWEL, the software gets lost and miscategorizes items in droves.
Even if you did give a good faith effort to report everything using software and manual combing, you probably messed something up, or flat out missed an item of income. So, what is the IRS likely to care about, and more importantly, what will be the easiest tax evasion for them to prove? Well, this is where the off-ramping transactions come into play. On paper gains are great and all, but at the end of the day most IRL purchases or TradFi vehicles require your crypto gains to be converted to fiat. The main way to do that right now is through KYC exchanges. IF you used Coinbase, FTX, KuCoin, or really any other major exchange to convert your hard earned profits into fiat, and you did NOT report those transactions, you could be in the line of fire. You should also note that those institutions are required under US law to report your taxable activities to the IRS, so whether or not you were forthcoming, the IRS has that information.
But, Sir Esquire, I did report my off ramping transactions, I just couldn’t bare to do all my on chain activity. Well, as long as you reported fiat conversions, you’re probably OK (this is NOT legal advice, you should report all your income, but the odds are in your favor). For example, if you were leverage trading SOL on a non-KYC platform, hit a nice trade, moved those proceeds to your Phantom wallet and then swapped the SOL for some other token via DeFi, you technically did partake in multiple taxable transactions. However, in that hypothetical you haven’t exchanged for fiat yet, so all your activity is on chain, and frankly, really hard to follow.
This is all to say, I would be most worried if you didn’t report crypto in an “off ramping” transaction, or if an employer, or other identifiable income provider, paid you in crypto. As a side note, in the latter case, you would have had to report the fair market value of the crypto at the time you received it as income, as opposed to it’s value when you liquidated it (aka, big YIKES on paying taxes on BTC at $65K only to see it drop through the floor months later).
Does the IRS actually have the man power and expertise to successfully scour the blockchain to determine tax fraud?
To audit all crypto tax evasion? lol hell no. However, (and this ties in question three) they will pick random people to make examples out of. But even putting that aside, do they have the expertise to accurately audit taxable transactions? It’s impossible to say without knowing who the IRS has on the job, but you know they’re not all going to be idiots. The IRS draws smart motivated people, so as much as I’d like to believe they’re a complete dinosaur organization that isn’t up to the task, I do think they’ll be able to tackle obvious evasion.
Of course, there is a reason they’re focusing on “off ramping” and easily identifiable income, and that’s because on-chain transactions take an incredible amount of time and man power to track. Even personal auditing of my own transactions was incredibly difficult, and I do this every single day. I find it hard to believe someone with little to no experience actually trading crypto on a daily basis will be able to ever fully manually audit on chain activity.
The only thing that would make that truly possible is if some giga brain makes a high functioning audit software. If that is the case, I would hope they commoditize it for retail use instead of narcing it to the IRS, but that remains to be seen. That said, the IRS did create an Office of Cyber and Forensic Services last year to specifically make mass crypto auditing possible, so we’ll see what their competence level is.
Are you going to be unlucky enough to have been selected as an audit guinea pig?
Knowing your luck? Probably. Pray (especially if you’re a whale who rolled the dice).
Conclusion
There are tens of thousands of active crypto traders in the US. “Hundreds” of cases may sound scary, and some of these cases will doubtless be example makers, but it’s a drop in the bucket.
The moral of the story is that the IRS does care about tax evasion, even in crypto, and it’s absolutely worth reporting your fiat conversions and other crypto income from employers or independent contracting gigs. On chain activity is still probably a couple years away from being easily auditable, so if that’s where you skimped out this year, you’re probably fine. In any case, the IRS has seen enough of your shit posting tweets joking about tax evasion, and they’re sick of it. Expect this to be a growing theme as time goes on.
I’ll do a follow up post on this once some of the details on the cases come out, but until then, godspeed.