Dogecoin, Shiba, Bitcoin, Ethereum. If none of those sound familiar, then you might have been living under a rock the past few years. From online forums to mainstream news networks, crypto has been a hot topic. We have seen people lose fortunes to crypto, while others got rich seemingly overnight. Because crypto is such a new technology, the final verdict on some of the more complex tax issues related to it are up in the air. While the future holds many uncertainties on how crypto tax issues will be litigated, income that comes from crypto is taxable income like it would be if it came from any other source.
The novel nature of the technology surrounding crypto currency leads to many transactions not being reported to the IRS. Therefore, if a taxpayer’s only source of income were crypto transactions, it is possible that IRS has not been made aware of a filing obligation for that taxpayer. Please note that whether the IRS receives a 1099 for the crypto transaction or not, gains and losses in crypto currency must be reported on a US federal income tax return subject to the following rules governing short/long-term gains/losses:
- Gains/losses held less than a year are considered to be short-term gains/losses and are taxed at the individual’s normal income tax rate
- Gains/losses held for a year or more are considered to be long-term gains/losses and are taxed at the lower capital gains tax rates.
The difficulty in cracking down on crypto users lies in the way that value can be transferred freely across different platforms. Many crypto trading platforms are decentralized at least to a degree. This means that some users are able to trade crypto on certain platforms with no identity verification. This is in contrast to securities trading platforms like Ameritrade which require a social security number to create an account. With no identity verification, the IRS would have to do serious forensic accounting to find exactly who made the trades; obviously the IRS does not have unlimited resources to crack down on everyone. While this may sound like a free pass to avoid taxes, it should be noted that underreporting income and failing to file a tax return are subject to the following penalties:
- Failure to File Penalties
- Failure to File penalties accrue at 5% of the unpaid taxes for each month or part of a month that a tax return is late. The Failure to File Penalty does not exceed 25% of your unpaid tax liability. Interest also accrues on these penalties until a taxpayer pays their balance in full.
- Underreporting Penalties
- For individuals, a substantial understatement of tax applies if you understate your tax liability by 10% of the tax required to be shown on your tax return or $5,000, whichever is greater. The penalty for substantial understatement is 20% of the portion of the underpayment of tax that was understated on the return.
- Failure to Pay Penalties
- Failure to Pay penalties accrue at 0.5% of the unpaid taxes for each month or part of a month that a tax return is late. The Failure to Pay Penalty does not exceed 25% of your unpaid tax liability. Interest also accrues on these penalties until a taxpayer pays their balance in full.
- Criminal Prosecution
- Failing to file a US federal income tax return potentially subjects offenders to up to 1 year in federal prison per offense, and a fine of up to $100,000.
- Willful tax evasion is punished by to up to 5 years in federal prison per offense, and a fine of up to $100,000.
What To Do If You Have Un-filed Crypto Income
As discussed above, the consequences for improperly handling your federal income tax obligations related to crypto currency can be severe. If you realize that you have un-filed returns, your first step should be immediately contacting an attorney. While it may seem like an accountant would be helpful in this situation, contacting them first in a case of non-filing is a bad idea because non-filing turns your tax issue into a criminal matter. Speaking first with an attorney is important because only communications with an attorney are protected by attorney-client privilege if the IRS decides to prosecute a taxpayer criminally for failing to comply with federal income tax filing requirements; this means that unlike an accountant, an attorney generally cannot be called to testify against the taxpayer when a taxpayer is under investigation by the IRS or other enforcement agencies.
A good tax attorney can also advise you through the IRS’s Criminal Investigation Voluntary Disclosure Practice. Think of the Voluntary Disclosure Practice as a proverbial amnesty program for non-filers who come forward prior to the IRS receiving notice of their noncompliance. The Voluntary Disclosure Practice can help the taxpayer in the following ways:
- Elimination of Failure to File and Failure to Pay penalties in exchange for a one-time fraud penalty on the highest year of tax liability. The fraud penalty often results in a substantially lower penalty for the taxpayer.
- Protecting the taxpayer from criminal prosecution as a reward for proactively coming forward about their failure to comply with federal income tax regulations.
Here at the Wilson Firm, we specialize in advising clients who have un-filed returns and would be happy to help steer you in the right direction to tax compliance to mitigate penalties and limit exposure to criminal prosecution. Please feel free to contact our attorneys for assistance.