IRS to Cryptocurrency Owners: How to Clean, or Else!

Tax specialists are urging crypto users who aren't in compliance to act quickly. While coming clean involves a maze of tricky decisions, ignoring the agency could cost a crypto holder dearly.

"I tell them," It 's time to put your running shoes on. "You must get to the IRS before they find you, especially if you got a letter," says

      Bryan Skarlatos,

       a criminal tax lawyer with Kostelanetz & Fink in New York.

Dealing with the IRS disclosure maze is Mr. Skarlatos’s specialty: He guided nearly 2,000 U.S. taxpayers through it when they confessed secret offshore accounts between 2009 and 2018. He performed triage for more, telling those with cases that would not land them in prison about simpler solutions.

The IRS's crypto crackdown has similarities with its offshore account campaign. Mr. Skarlatos has handled about a dozen high-dollar cryptocurrency cases.

Mr. Skarlatos says people in possible violation of IRS rules should first look for signs of tax fraud. It must involve intentional disobedience of the law. One clear sign is a large amount of unpaid tax, say above $ 15,000, he adds.

Other signs of fraud can be made to disguise cryptocurrency ownership, as by using an assumed name; using a “tumbler” service that mixes some cryptocurrency with others to obscure the original source; and a prior tax preparer — because the IRS will ask.

If there was fraud, the crypto owner will need a lawyer to provide attorney-client privilege. The owner should probably apply to the IRS's Voluntary Disclosure program, which often levies large civil penalties but protects against criminal prosecution.

If the wrongdoing wasn´t fraudulent, the crypto owner can often file what is called This will avoid some penalties but not interest.

There is an important exception for crypto owners who weren't fraudulent but are already known to the IRS. This category includes people who were out-of-court upon request of Coinbase, the leading cryptocurrency exchange, to turn over information on 14,000 customers to the agency.

When the IRS contacts wrongdoers about an audit before they come forward, Mr. Skarlatos says, they often face larger penalties than wrongdoers who weren't known to the IRS.

The IRS is focusing on cryptocurrencies because their use is expanding, and enthusiasts often praise the anonymity virtual currencies offer. Many trades aren’t reportable to the IRS by third parties — unlike sales of stock shares, which must be reported to the IRS by brokerage firms.

An IRS analysis found that for 2013, 2014, and 2015, when more than 80% of returns were electronically filed, fewer than 1,000 e-filed returns each year reported transactions appearing to use virtual currencies. Coinbase said at the end of 2013 that it had 650,000 accounts. Now it has more than 30 million.

Cryptocurrency advocates are upset by the IRS’s campaign. They say the agency hasn't published long-promised guidance, including how to pinpoint some fair market values; which cost-allocation methods to use; or whether the agency favors a small exemption for personal use. Recently, 60% of global bitcoin transactions were below $ 600, according to Coin Metrics, a cryptocurrency data provider.

"The scary IRS letters tell people to 'accurately' or 'properly' report their transactions, but what's that? "Maybe they would have filed if they had clear answers and hadn't felt overwhelmed," he says

      James Foust,

       senior research fellow with Coin Center, an advocacy group.

Advocates also point out that tax reporting is onerous because the IRS classifies cryptocurrencies as property to stocks or to home. If someone uses bitcoin to buy a car or lunch, that is typically taxable sale — as it would be if the person paid in shares of stock.

If you are selling bitcoin is higher than its purchase price, then the profit is typically taxable at capital-gains rates. If it is lower, there may be a deductible capital loss. Frequent traders can have thousands of transactions to detail on IRS Form 8949, and cryptocurrencies' volatility can yield both gains and losses within a short period.

The IRS will dismiss these arguments, says

      Jordan Bass,

       a certified public accountant in Los Angeles who says cryptocurrencies, a specialty he turned to after advising friends with bitcoin.

"The tax framework has been clear since 2014," he says. "The IRS is not going to impose terrible penalties on good-faith efforts, but it will try to make an example of bad actors."

Write to Laura Saunders at [email protected]