IRS warns ‘crypto’ fans to include digital asset income on tax return … or else

America’s taxman is warning ‘crypto’ fans that their digital asset sales need to be reported on their tax returns, with serious repercussions for scofflaws.

Monday, April 15, marked the deadline for Americans to file their 2023 income tax returns with the Internal Revenue Service (IRS). Last week, the taxman’s criminal investigation chief Guy Ficco told CNBC that he expects a significant portion of ‘crypto’ fans will attempt to reduce their tax liability by understating their amount of digital asset income or failing to report any such income whatsoever.

Ficco said digital currencies have been part of IRS investigations “for years,” but malfeasance had traditionally been “part of other, larger frauds” like “scams, embezzlement, money laundering.” The IRS is now seeing “more of the pure crypto tax crimes,” including simply failing to report income from asset sales or “shielding the true basis in crypto.” Ficco said he expects to see more charges filed “in this year and going forward” as ‘crypto’ tax evasion increases.

Now assisting the IRS in identifying potential tax evaders are blockchain sleuths Chainalysis, just one of the analytic firms with which the IRS has struck public-private partnerships. Ficco said IRS agents “are phenomenal at tracing and following money” but partners like Chainalysis help provide “some of the tools and applications that are needed when we start investigating in the crypto world with obfuscation of true ownership.”

This partnership appears to be a two-way street, as Chainalysis announced last week that
Jim Lee, a 29-year veteran of the IRS and former head of the IRS-Criminal Investigation unit, had joined the company as its new global head of capacity building.

Lee said his fight would remain the same in the private sector, because “crypto is the future of finance, which also means it’s the future of crime.” Lee said his initial focus would be on “helping international agencies develop solutions against cryptocurrency-based crime” while also helping digital asset operators “build and maintain robust compliance programs.”

There are obvious benefits to the government in identifying digital asset tax evaders. Ficco said digital assets have been involved in “some of the biggest seizures the U.S. government has ever seen.” Ficco’s seen nothing to think these seizures will “dissipate” due to digital asset use becoming “more pervasive.” Ficco cited ‘pig butchering’ scams as a type of crime that was becoming increasingly reliant on digital assets to mask the trail of ill-gotten gains.

The IRS’s top-10 cases for the 2023 fiscal year included four related to digital assets. These cases included James Zhong, who stole around 50,000 BTC tokens from the Silk Road dark web marketplace (and was forced to forfeit the lot); BTC money launderer Ian Freeman; and the co-founder of the OneCoin fraud, Karl Sebastian Greenwood.

Done fooling around

In January, the IRS issued a reminder to taxpayers that they must “report all digital asset-related income” on their next return. The IRS’s definition of income includes all income-generating ‘crypto’ transactions—disposal of digital assets (including non-fungible tokens), receiving assets as payment for property or services provided, receiving assets via mining, staking, or similar activities, as well as receiving an airdrop of new tokens following a blockchain hard fork.

While the IRS currently conducts audits on less than 1% of all returns, that doesn’t mean you won’t be among the unlucky ones. In February, the Department of Justice (DOJ)
indicted a Texas resident who allegedly failed to report $4 million in gains from the sale of digital assets. The indictment marked the first time the IRS had filed tax evasion charges against an individual based on their digital asset income.

Frank Richard ‘Paco’ Ahlgren III potentially faces up to 29 years behind bars if convicted on multiple charges of failing to report capital gains made via sales of BTC, as well as structuring bank transactions to stay under the $10,000 ceiling for currency transaction reporting requirements.

Ahlgren realized “substantial gains” worth millions of dollars from the sale of BTC in 2017 but allegedly inflated the price he originally paid for the tokens, thereby minimizing his perceived gains. He sold another $650,000 worth of BTC during 2018 and 2019 but failed to report any of these sales on his returns for those years.

Ahlgren also sold some of this BTC to an individual for cash that he deposited in banks in a series of transactions, all of them staying under the $10,000 threshold to avoid triggering the reporting requirements.

Ahlgren appears to have obtained the cash he used to purchase his BTC by stealing funds from his father. An April 2022 federal court document indicates that Ahlgren “absconded” with assets held in trust for the benefit of his father and that Ahlgren “accumulated substantial wealth, mainly through purchases of cryptocurrency made possible by” these unapproved “contributions” from his father’s trust. (Reminder: Father’s Day is June 16 this year.)

The IRS previously announced plans to require third-party operators, including digital asset exchanges and decentralized finance (DeFi) platforms, to report customers’ digital asset transactions above $10,000. These plans were temporarily put on ice in January until guidance could be finalized on how the enforcement mechanisms would work.

To absolutely no one’s surprise, these efforts met with furious pushback from the usual suspects, including the Coinbase (NASDAQ: COIN) exchange. Paul Grewal, the exchange’s chief legal officer, summed up his company’s opposition by claiming that the rules would “harm a nascent industry when it’s just getting started.”

Of course, Coinbase has yet to meet a proposed digital asset regulation it actually likes, mainly because all rules interfere with the exchange’s ability to earn commissions off
pointless memecoin speculation.

Ironically, Coinbase’s VP of tax, Lawrence Zlatkin, sent the IRS a letter last October that claimed the exchange had “long advocated for a tax system that treats digital assets the same way it treats assets in traditional finance.” This is in stark contrast to Coinbase’s standard declaration that ‘crypto’ is so innovative and unique that existing rules governing traditional finance operators are hopelessly inadequate.

Good thing there’s no penalty for evading consistency, huh?

Watch: It’s time for regulation to enable blockchain growth