BTC and Tax in the US: Key Points to Remember
Before we start explaining how the IRS tracks crypto, here are a few important things to keep in mind:
The IRS treats virtual currency as property for federal tax purposes, so if you exchange, sell, buy or receive crypto assets as a gift or as a payment in your business, you need to report the profit and losses (short and long-term) you make on your annual tax return. Any interest you earn from mining and staking is a taxable event as well and needs to be reported to the IRS.
- You need to report crypto transactions to the IRS
The U.S. tax system is based on voluntary compliance, meaning that it is the taxpayers’ responsibility to report taxable events whether the IRS knows about them or not. So, to avoid serious fines and penalties, you need to include your crypto gains in your annual tax return before the IRS starts looking at your accounts.
- The IRS will continue to crack down on crypto investors who underreport
As the crypto ecosystem grows, the federal government employs more advanced technologies and resources (including sophisticated data analysis, pattern recognition, and AI)—leaving no stone unturned when it comes to going after taxpayers who underreport.
How is Bitcoin traceable?
First off, crypto transactions are not as anonymous as one might think. Actually, transactions on blockchains such as Bitcoin and Ethereum are publicly visible since they are stored on the public digital ledger. This means that a government agency, like the FBI and IRS, can use a transaction ID and a blockchain explorer to locate the relevant wallet address (or the other way around) and see all the transactions the wallet has carried out.
What’s more, linking the wallet address to the user is becoming easier since crypto exchanges have increased the amount of personal information they request from their customers in order to comply with government regulations.
Know-Your-Customer (KYC) verification
All centralized crypto exchange platforms must have KYC verification to be able to legally operate in the US. This applies to both new and existing users.
Although KYC procedures vary, all include basic information such as your name, address, and ID. This is considered the bare minimum and is usually enough for the IRS to identify you.
However, with KYC verification evolving, some crypto exchanges might also ask you for information such as a photo of yourself with your ID or biometric identification. Others might request banking information and a phone number, making it easier for federal agencies to monitor your crypto asset trading activity.
How Does the IRS Track Bitcoin?
There are several ways the Internal Revenue Service can learn about your crypto trading activity.
Form 1099-K and Form 1099-B
If you get a Form 1099-K or Form 1099-B from a crypto exchange you have used, then the IRS definitely knows that you have engaged in crypto trading activity.
Form 1099-K shows monthly proceeds and is issued to all users who have more than $20,000 in proceeds and at least 200 transactions in cryptocurrency in a tax year. Form 1099-B lists all the transaction processes carried out through a brokerage.
How does the IRS know about these forms?
Most crypto exchanges issue these forms for eligible users —sending one copy to the account holder and another to the IRS. If you file a tax report and do not include the amounts in the form, the IRS computer system (which works on a matching mechanism) will automatically detect those tax returns and flag them for under reporting.
Note: Many exchanges have started sending out Form 1099-MISC (used to report miscellaneous income) instead of Form 1099-K and Form 1099-B believing this to be more suitable for reporting crypto gains.
Court subpoenas
The IRS has issued several subpoenas in the past, most notably to Coinbase which had to disclose data on about 13,000 user accounts in 2018, including taxpayer identification numbers, names, birth dates, addresses, transaction logs, and more.
In 2019, the IRS subpoenaed the records of Bitstamp regarding a certain taxpayer who used the services of the platform after he filed an amended return asking for a $15,475 refund for taxes he had previously paid on reported gains from crypto.
The IRS has also issued John Doe summons to Circle and Kraken as well as other exchanges.
So, can the IRS track Bitcoin and other cryptocurrencies with subpoenas?
Yes, a John Doe summons compels the exchange to share information on user accounts allowing the IRS to identify, audit, and prosecute taxpayers who have been underreporting. Although this is a lengthy process, it is highly effective in tracking down non-compliant taxpayers.
Note: If you are thinking that funds withdrawn to your wallet don’t count, remember that crypto exchanges have access to your crypto addresses and can share this information with the IRS if compelled to.
Form questions
In 2019, the IRS added a virtual currency question to Form Schedule 1 asking point-blank if the taxpayer has made any profit from crypto assets in that year.
However, not all taxpayers file a Schedule 1 (usually reserved for income not listed on Form 1040, like gambling winnings, alimony, and capital gains), so the following year, the IRS moved the question to Form 1040—used by all persons who file an annual tax return.
Answering ‘Yes’ to this question will have no impact on your tax liability. On the other hand, answering ‘No’ while using one of the exchanges that report to Uncle Sam is a huge red flag for the IRS, who may and probably will audit you.
Remember that the statute limit for an IRS audit is 36 months after the taxpayer originally failed to file their tax return properly. However, if fraud is involved, there is no limit to how far back the IRS can go.
Which Crypto Exchanges Report to the IRS?
It can be hard to determine which cryptocurrency platforms report to the IRS or how many of them do so. While some are open about the issue, many don’t want to risk losing customers by admitting they disclose user information—after all, anonymity is one of the major appeals of crypto.
One definitive way of knowing whether your exchange reports to the IRS is 1099 forms. If the crypto platform you used in the past year has sent you a 1099 form, the IRS knows about your trading activity as they also get a copy of the forms.
Here is a list of the exchanges known to send out Form 1099-K or Form 1099-B:
- Coinbase
- Binance US
- Bitstamp
- Kraken
- eToro
- Gemini
- Crypto.com
- Robinhood Crypto
Given the measures taken by the IRS to detect and identify tax evasion, it is likely that the list of crypto exchanges reporting to the federal government will increase in the future.
Are there any crypto exchanges that don't report to the IRS?
Yes, there are a few that do not report to the IRS, i.e. do not issue 1099 forms or collect KYC information.
These include
- KuCoin
- OKX
- CoinEx
- Local Crypto
- Hodl Hodl
If you are thinking that you can avoid reporting gains on crypto by signing up to one of these platforms, think again.
First off, many of these exchanges are not allowed to operate in the US (and several other countries). This means that the platform could freeze your account when you try to withdraw funds by using a US-based IP address.
Secondly, most of these companies impose limits on specific features. For example, OKX does not support P2P trades without KYC, while KuCoin has withdrawal restrictions for users who have not met KYC verification requirements.
Last but not least, KYC procedures are put in place to protect the consumer, so it’s always better to go with a platform with KYC than one without. A tax bill will usually cost much less than a hack or breach on the exchange causing you to lose all the money in your account.
What about non-custodial wallets?
The latest developments on the crypto scene have increased the popularity of decentralized wallets. These do not collect KYC data or personal information (meaning they have nothing to share with the IRS even if they receive John Doe summons), however, the situation is not always that clear-cut.
For one, some wallets, like Trust Wallet, allow you to link your credit or debit card to make purchases. Since banks are legally obligated to share these transactions with federal authorities you can rest assured that the IRS will get the information and take an interest in your crypto dealings.
What’s more, several non-custodial wallets have announced changes to their privacy policies, such as tracking IP and Ethereum addresses when a transaction is completed. While this information is not currently being shared with third parties, there is no guarantee that it won’t be disclosed to authorities in the future.
On top of this, transferring crypto between your centralized and decentralized wallet can also get flagged by the IRS when the exchange sends you 1099 forms.
What do I need to report about crypto to the IRS?
You basically need to report everything about your crypto transactions, including but not limited to
- The date the asset was acquired or sold, plus the nature of the transaction and the parties involved;
- The price the asset was purchased and sold for;
- Fair market value of the crypto asset in USD;
- Capital gains and losses you realized from the asset;
- Records of all transactions and transfers from your crypto wallets and exchange accounts, including receipts of purchase and sale
This is a lot of information to keep track of. Plus, collecting all the data and calculating it manually is just too much work. Luckily, there are plenty of powerful and accurate crypto tax software tools that can automatically import and prepare tax forms, helping you meet all the requirements of the IRS without breaking a sweat.
Bottom Line: Can You Avoid Paying Taxes on Crypto?
You could try a few strategies to reduce the amount payable to the government, but you cannot avoid paying tax on crypto, nor should you try to.
When it comes to Bitcoin and other digital currencies, the IRS is watching! In fact, they monitor activity more closely than ever before, gathering data from major exchanges or crypto-related businesses. So, instead of trying to trick Uncle Sam, crypto investors should spend their energy and time preparing tax returns properly. It’s worthwhile to consult a tax professional for additional help when preparing and filing tax returns. Alternatively, you could sign up for one of the many crypto tax software companies—most of them have in-house CPAs and tax attorneys.
Remember that a tax bill will almost always be lower than the fines and charges imposed by the IRS for tax evasion.
FAQs
Do crypto exchanges report to the IRS?
Yes, several cryptocurrency exchanges have already confirmed that they report to the IRS, such as Kraken, Coinbase, Binance, and others. Crypto exchanges send a copy of 1099 forms to the IRS as well as the user, so if you get one of these forms, know that the government has one too. Even if a crypto exchange does not issue 1099 forms, they still collect personal information on you and could share these with the IRS if legally compelled to.
Can the IRS track NFTs?
Yes, NFTs transactions on blockchains are publicly visible. In other words, they can be tracked by the IRS using the same methods for monitoring trades involving Bitcoin and Ethereum.
What should I do if I forgot to report my cryptocurrency in the past?
The IRS doesn’t really care if you forgot or simply tried to avoid paying taxes. If they find out that you have been underreporting, they can and most likely will audit you.
The first step to take would be to consult a seasoned tax advisor or accountant—they can provide expert help and advice. Usually, a tax advisor will tell you to amend your tax return for the years you did not add your crypto profits (you have three years to do this). There is no guarantee that you won’t face tax evasion penalties, but in general, the IRS tends to be less strict with taxpayers who make a genuine effort to fix their mistakes.
You could also take a look at Form 14457, which was updated last year to include crypto assets.
Do you have to pay taxes on Bitcoin if you don’t cash out?
Even if you don’t exchange or sell crypto, you are still obligated to report any profit to the IRS. So, if you earn interest from staking or mining, this too is a taxable event and should be included in your tax return.
