If you want to stay on the right side of the IRS, you’ll need to comply with its rules on digital assets. Accurately reporting cryptocurrency is essential when you file your income tax return. Forgetting to report crypto transactions on your taxes can be costly. So, what happens if you don't report cryptocurrency on your taxes?
How Is Cryptocurrency Taxed?
The IRS treats cryptocurrency as capital assets. If you sell crypto for more than what you paid for it, you owe tax on the gain. For example, if you pay $500 for crypto and later sell it for $800, you report a $300 capital gain on your tax return.
The same concept holds if you swap crypto or use it to pay for goods or services. Swapping $500 of bitcoin for ether and then selling it for a profit of $300 triggers a $300 capital gain. Similarly, if you paid $500 for crypto and it grows in value to $800 and then you use it to buy goods, you report a $300 capital gain.
How much you pay in tax depends on how long you hold the crypto. If you sell, swap or use crypto you’ve owned for less than one year, you pay short-term capital gains tax. Short-term capital gains tax rates are the same as the ordinary income tax rates you pay based on your adjusted gross income. You could pay up to 37% tax on short-term capital gains, depending on the tax bracket you fall into.
You apply long-term capital gains tax rates when you sell, swap or use crypto you've held for more than one year. Long-term capital gains tax rates fall between 0% to 20%, based on your adjusted gross income.
What Happens When You Don't Report Crypto on Your Taxes
Failing to report taxable crypto events on your return can be costly. Not only can you find yourself owing more money, but letters you get from the IRS can be unsettling.
Tax return adjustments
If you fail to report crypto gains, the IRS could adjust your return and send you a bill for the taxes you owe. When your adjusted gross income increases, you could pay even more tax if you end up in a higher tax bracket. Plus, the IRS charges interest on the unpaid taxes you owe.
Penalties
If you underpay tax, you could be hit with a substantial penalty. When you disregard tax rules or don't make a reasonable attempt to follow tax law, the IRS could charge an accuracy-related penalty of up to 20% of what you owe.
In addition, the IRS could charge a penalty if you substantially understate the income tax you owe. If your tax liability is understated by 10% or $5,000, whichever is greater, the IRS could hit you with a 20% substantial understatement of income tax penalty.
Plus, the IRS charges interest on the penalties owed.
IRS Audit
The IRS may select your return for audit. An IRS audit may include the previous tax returns filed for three years. The IRS could tack on additional years to the audit if it finds substantial errors while examining your returns. Your tax returns will undergo more scrutiny. If you cannot provide good records to support your income and deductions, you could end up owing more taxes, penalties and interest.
Criminal Investigation
You could be subject to a criminal investigation if you violate tax laws or don’t comply with your legal responsibility of filing and paying taxes owed. You could face imprisonment or fines.
Understanding Crypto Tax Evasion
The IRS may find you've evaded taxes when you don't report crypto on your tax return. The two types of crypto tax evasion include:
- Evasion of assessment: Crypto tax evasion may happen when you file a false tax return that omits income. Evading a correct assessment of your taxes occurs when you willfully underreport your income.
- Evasion of payment: Once a tax liability has been established, an evasion of payment occurs when you conceal the assets you have that could pay the debt you owe.
How Does the IRS Find Out About Unreported Crypto?
The IRS employs several strategies to track down taxpayers who fail to report taxable crypto transactions. By leveraging technology to analyze crypto transactions and identify patterns of activity, the IRS could flag possible tax evasion or fraud.
Common ways the IRS can trace unreported cryptocurrency transactions include:
- Third-party reporting: Exchanges report user activity, including transaction amounts and the parties involved.
- Blockchain analysis: The IRS can monitor crypto transactions on public ledgers through data analysis.
- Subpoenas: The IRS may use subpoenas to collect user data on exchanges based on specific criteria.
- Collaborate with other agencies: The IRS works with other agencies and international organizations to keep up to date on trends and techniques used to commit crypto crimes.
How to Deal With Unreported Cryptocurrency
If you realize you still need to report cryptocurrency gains on your tax return, quickly resolving the issue can be critical. A few steps you can take steps to correct the problem include:
Amending Your Return
If you have unreported cryptocurrency transactions, it’s a good idea to amend your tax return as soon as possible. You can amend a return with the IRS on Form 1040-X.
Voluntary Disclosure
Taxpayers who may face criminal proceedings for willful violation of tax law may voluntarily report information that they previously failed to disclose to the IRS. Additionally, the taxpayer must cooperate with the IRS to determine the correct amount of taxes owed and pay the total amount of taxes, penalties and interest. If you cannot pay what you owe in full, you may submit a proposed payment plan for the IRS's consideration.
Filing a voluntary disclosure with the IRS can help taxpayers address their tax situation before IRS enforcement happens.
Do I Have to Report Crypto if I Lost Money?
Taxpayers must report all income related to cryptocurrency transactions. Even if you sold or swapped crypto at a loss, you should include this activity on Form 8949 Sales and other Dispositions of Capital Assets when filing your income tax return.
When you sell or exchange crypto, any gains or losses on these digital assets held for more than one year may offset each other. Similarly, you can offset gains and losses on sales or swaps of crypto held for one year or less. Once you’ve listed all crypto activity on Form 8949, you’ll report the totals of each category on Schedule D of your Form 1040.
Avoid the IRS Headache: Report Crypto on Your Taxes
No one enjoys paying taxes. Yet if you miss reporting crypto on your income tax return, the IRS may come looking for you. You can quickly get hit with penalties, interest or worse. Keeping good records and accurately reporting crypto can relieve the stress of filing taxes.