Crypto Tax Evasion Risks: What You Should Avoid

When people hear the word tax evasion, they think of criminals locked up in jail or wealthy businessmen who are serving time. What most don’t realize is that tax evasion is a crime that is easily committed—especially when knowledge is lacking.

You could be accused of tax evasion just because you fail to report your cryptocurrency capital gains. We aren’t making this up. Read on to learn about the mistakes that lead to cryptocurrency tax evasion so you can avoid them.

Disclaimer: This article is specifically written for United States residents who pay US taxes. While many countries have crypto reporting requirements, know that some of the information listed here isn’t applicable to those living in other countries.

Cryptocurrency Tax Mistakes to Avoid

1. Know the Tax Laws in Your Area

The number one way to avoid accidental tax evasion is by taking the time to familiarize yourself with your local laws. Not only do you need to know the Federal crypto laws for your federal return, but you also need to look at the state laws for your state return. If you use a program like TurboTax or H&R Block, they should be able to direct you through the steps to claim your crypto taxes.

Those doing their taxes on their own should, at a minimum, know whether or not they had any capital gains from their cryptocurrency in the previous tax year.

2. Know Your Holdings

Most centralized cryptocurrency exchanges will provide you for the paperwork you need to report your holdings to the IRS. However, if you use a decentralized exchange, like Uniswap, you will need to report on your own.

We recommend keeping a spreadsheet of all your holdings and how much you have bought and sold over the year. If you are a crypto day trader, you will likely need to use accounting software or hire an accountant to ensure you pay proper taxes on your holdings and earnings.

3. Ask for Help if You Need it

Tax law is notoriously difficult to navigate and the US government is actually hoping that you mess up and then pay them extra. Therefore, if you find yourself struggling to file your cryptocurrency taxes on your own, don’t be afraid to hire a consultant.

Most tax companies offer a consultation for a flat fee, though very complicated cases may require hiring a certified accountant; in that case, we assume you have made enough money to afford it.

4. Know What Counts as Cryptocurrency and Capital Gains

The cryptocurrency space is no longer just Bitcoin. Now it includes a number of blockchains, services, and even artwork like NFTs.

While NFTs don’t always require taxes to be paid, they often do, so make sure you know all of your cryptocurrency assets and their approximate value before you file.

Cryptocurrency Tax Evasion: The Consequences

Many individuals who trade crypto have a false sense of anonymity, thinking that the US government can’t track their offshore accounts or decentralized exchanges.

While this can be true, the US government is growing increasingly smart when it comes to tracking its citizens and their cryptocurrency transactions. Even though you may use a decentralized exchange, the US government has access to more resources than you realize.

For example, if you transfer funds made from a decentralized trade to your bank account to pay for bills, you might find that the US government shows up at your door to ask you where the money came from. At that time, if you don’t have the proper proof, you could find yourself in trouble.

Not only that, but the IRS now has access to blockchain analysis, allowing them to monitor blockchain activity, make connections between accounts and transactions, and track down individuals who assumed they were anonymous.

Some of the consequences of tax evasion are as follows:

·      Fines higher than the original tax you owed

·      Criminal charges

·      Time in jail or prison

·      Civil penalties

·      Seizure of assets

·      Damage to reputation

Of course, the consequence you will face will depend on where you live, as well as how large an error you made. Regardless, tax evasion is a serious crime, and you should do all you can to ensure you aren’t accused of it.

What Triggers an IRS Audit?

There is no way to know for sure whether or not you will be audited. But there are certain actions or activities that raise the chances that your account will be selected for audit.

The most important thing to know is that the IRS uses an automated system to pull up accounts that may require an audit. This means that even a typo, or honest error could trigger an audit.

In general, this automated system matches reported income from businesses with individual tax filings—and if numbers don’t match, you’ll end up in an audit pile. So, double-check everything that you enter into your taxes.

Another thing that is flagged by the system is individuals who report lots of business expenses. The algorithm combs through these, and if they find something mentioned that isn’t a business expense, your number is added to the audit pile.

High income is another reason you may be audited. In general, individuals making less than $40,000 rarely end up in the audit pile (unless their job reported a higher income), and this is because if these individuals are audited by the IRS and found not to have paid enough taxes, the amount owed is generally too low for the IRS to cover the cost of the audit.

For example, an individual making $40,000 usually owes around $2,816 for their taxes for the year. Say they pay $2,000, but skip paying the $816. The IRS must audit and prove the individual owes the $816, but this can be time-consuming, especially if the individual had deductions that led to their original underpayment. Auditors are paid a high hourly wage, and the hours it takes to find the individual who owes $816 isn’t worth what the IRS will pay the employee to do it.

For this reason, the IRS only audits 1% of filers making less than $200,000 each calendar year.

That being said, just because you are unlikely to be audited doesn’t mean you won’t be. So always ensure you file taxes on your cryptocurrency sales correctly the first time around, or prepare to deal with the consequences.