The Consequences of Failing to Report Cryptocurrency Transactions
The sharp decline in cryptocurrency prices in 2018 has many pundits talking about the viability of tax loss deductions. But, neglecting to report cryptocurrency losses may be the least of the industry’s problems.
Interestingly, 2017 saw mounting cryptocurrency prices and exponential growth in blockchain wallet users. Yet, according to Credit Karma, less than 0.04% of the federal tax returns prepared and filed by its customers last year reported any cryptocurrency gains and losses.
One year later, aside from cryptocurrency prices, not much has changed. According to Credit Karma, most Americans aren’t planning to report their cryptocurrency transactions on their 2018 returns either – despite many being eligible for significant tax deductions. Credit Karma estimates that Americans lost $1.7 billion and had unrealized losses of more than $5 billion in the 2018 crypto bear market.
So, what is preventing U.S. crypto investors from claiming the tax deduction that they’re entitled to receive? The answer is as unfortunate as it is preventable, and it can be summed up in one word: “uninformed.”
According to a recent survey, many crypto investors believe that their losses were too small to seek a tax deduction. More than a third of survey respondents said they didn’t believe they were even required to file, and one fifth of respondents claimed that they simply didn’t know how to report.
Apparently, many people don’t consider a $50 trade on Coinbase an investment, but it is. Many people believe that a mere exchange of cryptocurrency is not a taxable event, but it is. And, it is taxable whether the exchange involves “government declared legal tender” or not. There are even tax consequences for when cryptocurrency is being used merely to pay for goods and services.
The tax treatment for cryptocurrencies is nebulous due to limited IRS guidance and clearly not well understood by taxpayers. “Because digital currency trading platforms are currently not required to issue conventional 1099s to taxpayers, with some limited exceptions, many smaller crypto investors don’t feel obligated to report their gains, especially in the 2017 ‘boom’ year. This would be a gross misjudgment. Taxpayers who do not properly report the income tax consequences of virtual currency can be audited for those transactions and can ultimately be liable for steep penalties and interest,” cautioned Tom Cardinale, EisnerAmper Tax Partner. “Furthermore, those who believe that they’ll be shielded from audit by the IRS’s three-year statute of limitations could be in for a rude awakening. The three years becomes six if a more than 25% omitted gross income threshold is met, and no time limitations if tax fraud is found.”
And don’t bank on “I dunno” serving as a viable defense. According to Walter Pagano, Tax Partner and Tax Controversy practice leader at EisnerAmper: “The widespread publicity of cryptocurrencies makes it nearly impossible for taxpayers to credibly claim ignorance as a defense.”
Perhaps most concerning is that unreported crypto gains from prior tax years could ultimately force crypto investors to liquidate significant positions at lower prices in order to pay outstanding tax liabilities to the IRS. This could end up putting further downward pressure on cryptocurrency prices.
The most prudent thing that crypto investors of all sizes can do for themselves – and for the cryptocurrency market – is to simply report.