Hello Folks. Well, it's that time of the year again...

The Internal Revenue Service (IRS) building stands in Washington, DC. April is the deadline in the United States for residents to file their income tax returns. 

As another tax season arrives, one of the major questions crypto holders have is how does the IRS know if someone has cryptocurrencies?

Before I describe the ways that the IRS knows about your crypto holdings, note that the United States tax system, relies on a voluntary compliance system. This means that the IRS expects you to report all taxable transactions, whether the IRS knows about those transactions or not; in a given year because it is required by the internal revenue code. Failure to do so may carry massive penalties. While keeping that thought in mind, let us dive into ways the IRS may find out about your crypto holdings. 

Tax Forms K & B: 

If you receive a Form -K or Form -B from a crypto exchange, without any doubt, the IRS knows that you have reportable cryptocurrency transactions. This is thanks to the “matching” mechanism embedded in the IRS Information Reporting Program (IRP). Here is how it works:

During any tax year, if you have a substantial amount of proceeds and transactions in a crypto exchange, you will get a Form -K, indicating proceeds for each month. The exchanges are required to create these forms for the users who meet the criteria. A copy of this form is provided to the account holder, and another copy goes to the IRS. If you file a tax return and do not include these amounts, the IRS computer system Automated Underreporter, AUR automatically flags those tax returns for under-reporting. This is how you get tax notices like CP.

If you receive a Form -B and do not report it, the same principles apply. 

Likewise, Coinbase, Kraken and other US exchanges do report to the IRS. Therefore, if you receive any tax form from an exchange, the IRS already has a copy of it, and you should definitely report it to avoid tax notices and penalties.

Subpoenas:

Over the past few years, the IRS has issued subpoenas to several crypto exchanges, ordering them to disclose some user accounts. For example, Coinbase had to disclose user accounts, including taxpayer identification number, name, birth date, address, records of account activity, transaction logs, and all periodic statements of account or invoices, or the equivalent pursuant to John Doe summons.

On another occasion, the IRS subpoenaed Bitstamp to release more information about a taxpayer who filed an amended return and requested a refund. 

Schedule Virtual Currency Question:

Starting tax season, on Schedule, every taxpayer has to answer at any time during the year, whether you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency Cryptocurrency question. 

This is an extremely broad question and will require you to check “yes” even if you are just holding crypto in an exchange or wallet. If you mark “yes”, first & foremost, it would signal the IRS to check various forms & schedules of the return for cryptocurrency gains & losses. However, everyone who marks “yes” may not have a reportable taxable event. For example, if you just held Bitcoin and did not sell, you would not have any taxable amount to report. In these cases, the IRS will use the cryptocurrency question as a way to gather data about United States crypto holders and keep an eye on future years for taxable events. 

These are some ways the IRS knows you have Bitcoin and potentially owe crypto taxes. The US tax system is voluntary, and it is your responsibility to report all transactions, whether the IRS knows about it or not.  

This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.

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