How The IRS Identified 10,000 Cryptocurrency Holders Who Received Warning Letters?

The IRS has started an active campaign to up the compliance by crypto holders to tax policies. In a letter issued to 10,000 who “forgot” to report their gains, the agency clearly warned that crypto activities or other virtual currency transactions are taxable. Furthermore, it affirmed that it has the right to persecute people that had failed to accurately report these transactions on a federal income tax return.

As expected, the campaign has spurred a wave of commentary on the misconceptions surrounding crypto tax policies, and the potential consequences of finding oneself in the bad books of the IRS. Although this apparent clampdown on crypto-related tax evasion is not one of the agency’s tax evasion crackdown initiatives announced this year, the agency has somewhat indicated in the past that it is looking to take a firmer stance on the laxity of crypto investors to tax issues.

Recall that the IRS claimed that only between 800 and 900 people had electronically filed their cryptocurrency-related earnings between 2013 and 2015. It is safe to say that this revelation might have spurred the agency to list the enforcement crypto tax laws as one of the core campaigns it would embark on last year. And judging from the precision and volume of the letter sent to crypto holders, it is obvious that the IRS has invested a lot of resources into getting the better of crypto investors.

What Does the Letter Say?

From what I have gathered so far, the letters sent to taxpayers are of three versions — letter 6173, letter 6174, or letter 6174-A. One version merely notifies the recipient that the IRS is aware that he or she has at one time or the other dabbled in cryptocurrency activities. Letter 6174 A, on the other hand, alleges that the individual had not accurately reported his or her transactions involving digital currencies. Regardless of the type of letter that you might have received, or would receive, make sure you follow the procedures highlighted in the letter, especially if you are a defaulter.

CP2000 Letter by CoinDesk on Scribd

This page is unavailable

This page is unavailable.

Copyright © 2022 Scribd Inc.Terms

It is important to state here that crypto tax laws in the US, like in many other countries, is still unclear. According to the IRS guidance released in 2014, however, virtual currencies are capital assets. Crypto holders are obligated to report the gains and losses incurred from cryptocurrency transactions. And this applies once the cryptocurrency has been exchanged for fiat currencies.

In other words, for someone who holds virtual currency on its behalf, he or she must note the market price, as well as the selling price, to ascertain whether the investment generated profits or incurred losses. Subsequently, the crypto holder would pay between 10% and 37% of their profits as tax, depending on how long they had held the cryptocurrency. Also, holders that have incurred losses can write them off by reporting the losses.

For instance, if you had bought 1 bitcoin for $6,000 in mid-2018, and later sold it at a loss for $3,200 in December, then you can capitalize on the capital loss deduction and have the $2,800 written off. Note that the maximum loss an individual can deduct from his yearly income is $3,000, while the remaining would get carried over to the next year.

How will the IRS Identify the “Culprits”?

You could be tempted to think that this crypto tax campaign is a bluff since the IRS would ascertain the compliance status of an individual only if they can link his addresses to him, and how long it was in his possession.

Contrary to this belief, the agency has all the resources and legal backings it needs to track all your crypto activities. Besides, bitcoin and a majority of cryptocurrencies cannot completely cloak your transactions from prying eyes. Truth be told, bitcoin and many cryptocurrencies out there are pseudonymous.

In essence, each crypto holder has an address, which reflects on the details of transactions. And once an entity can link the address to an individual, the individual’s identity and crypto activities are no more invisible.

So, the question is: How can an entity like the IRS uncloak your identity and track your transactions?

Perhaps the most common mistake that often leads to exposed identity is the unwise decision by some crypto holders to publish their addresses online. Likewise, your transactions are probably visible to the IRS if you buy goods and services from retailers or merchants in the US by paying with cryptocurrency. Also, once you have an account with exchanges domiciled in the US, and that have to enforce KYC and Anti-Money Laundering procedures on all their customers.

Remember that the IRS, through a court order in 2018, had forced Coinbase to surrender the personal details of 13,000 of its customers who owned at least $20,000 in their accounts and could have evaded tax. Therefore, one can assume that the 10,000 crypto holders served the warning letter could have emanated from the series of investigations carried out on the list submitted to the IRS.

More importantly, the IRS had enlisted the help of blockchain analytic firm, Chainanalysis, as a critical ally in its quest to impose tax laws on evading crypto-related investors. This move has given the agency the tracking power to comb through the millions of transactions on various public blockchain payment networks. As expected, Chainalysis is the preferred blockchain analytics tool for US government agencies. In September 2018, a report revealed that these agencies had collectively paid Chainanalysis 93% of the $5.7 million spent on tracking crypto users.

Judging by the recent backlash from the White House on the viability of crypto, it seems that the amount spent on tracking crypto activities will continue to rise. This assertion is more potent if you consider that these agencies are showing a growing interest in removing the anonymity that privacy-focused blockchains avail.

However, as noted by Tyson Cross, a tax attorney and the founder of Cross Law Group, the IRS letters are somewhat generic, as some of his clients that had accurately reported their crypto earnings had also received the letter. Therefore, if you are certain that you have complied to crypto tax laws, and yet still got a letter, you do not need to panic.