Does the IRS Know I’m Trading Crypto?

Dave Lemke, CPA - February 17, 2022

In 2020, the IRS added a question to its most popular tax return, Form 1040, which all working Americans know and love. The questions goes a little something like this:

At any time during 2020, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? Yes / No

Most people today would answer “no” to this question; however, for us, the crypto holders of America, the question triggers a few anxious thoughts, like:

  1. Am I going to get audited if I mark yes?
  2. Does the IRS already know my answer?
  3. Maybe I’ll say no, but drop $3 in the Presidential Election Campaign fund as a token of goodwill…

Rest assured, marking the crypto question yes should not trigger an IRS audit in and of itself. It appears the IRS is simply attempting to gauge how many taxpayers are invested in virtual currencies which it uses for data gathering purposes. But it also serves as an ominous reminder that gains and losses from crypto should be reported on the tax return.

So what does the IRS already know about us? For starters, it has a wealth of our information before we even file a tax return, such as copies of our W-2s, 1099s, K-1s, etc. By the time we actually file our tax return, the IRS already has a pretty good idea of what it expects to see. Not surprisingly, failure to precisely match what was already reported to the IRS is a fantastic way to get some love letters from an IRS agent.

When it comes to buying and selling cryptocurrencies, however, the IRS does not get our trades handed on a silver platter – yet. That will change in 2023, because Congress passed the Infrastructure Bill which cast a wide net in its definition of what a “digital asset” is and who a “digital broker” is. Beginning in 2023, just about any business that facilitates crypto transactions must report all gains and losses on Form 1099-B to each user and (surprise, surprise) to the IRS.

That doesn’t mean that crypto is a tax-free party before 2023. While it may seem like the owner of a crypto wallet is obscured enough to fly under the IRS’s radar, transactions are not anonymous and can often be connected to a specific human. For example, the IRS has used blockchain analysis services to connect off-chain identities with Bitcoin addresses and also served a summons on Coinbase to track down individuals who may have underreported their crypto income. Big brother is watching.

So while there is a chance to slip through the cracks when it comes to taxes and crypto, the best answer is always to keep the rules and never base a tax decision on the likelihood of an audit.

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