MW Why the IRS may be coming to tax your cryptocurrency

By Mark Hulbert

This is how many crypto investors evade taxes

Many have suspected that tax evasion is widespread among holders of cryptocurrencies. We just haven't known how widespread.

Until now.

A new study finds that 88% of cryptocurrency owners fail to properly declare their crypto on tax returns. The study may lead the IRS to more aggressively pursue these tax cheats, and financial advisers and CPAs need to remind their clients that they owe taxes on any gains realized from trading cryptocurrencies.

Whether more aggressive collection of cryptocurrency taxes dampens investor enthusiasm is anyone's guess. Part of the attraction of crypto is that they're not part of the traditional financial ecosystem and potentially off the radar screens of tax-collection agencies. But even prior to this new study, this was beginning to change. All along, ETFs that invest in cryptocurrencies, such as the iShares Bitcoin Trust IBIT, have been required to report transactions to the IRS; noncompliance presumably is not prevalent for investors in them. And beginning in 2025, the IRS is requiring centralized cryptocurrency exchanges, such as Coinbase, to report transaction data as well.

The study, "Crypto Tax Evasion," recently began circulating in academic circles. It was conducted by Tom Meling, a finance professor at Ohio State University; Magne Mogstad, an economics professor at the University of Chicago; and Arnstein Vestre, a Ph.D. candidate at that institution.

The researchers measured the level of crypto tax evasion because they were given access to detailed personalized account information at crypto trading exchanges in Norway between 2018 and 2021, as well as individual-tax-return data for those years. They focused on Norway, Professor Meling told me in an interview, for the simple reason that its government was willing to share with researchers the extensive financial data it collects on its citizens. He added, however, that there is no reason to believe that crypto-related tax evasion in Norway is particularly unusual; limited U.S. data suggest that the extent of tax evasion is very similar.

One reason the IRS may more aggressively pursue crypto tax evaders, notwithstanding President Trump's reputation as a "crypto president," is that the government will need to offset the cost of cutting corporate tax rates - and everything will be on the table. That's what happened in 2017 during negotiations over how to pay for the corporate tax cuts that were part of that year's Tax Cuts and Jobs Act. Sources inside the Treasury Department told me at the time that they were directed to consider adopting any of a long laundry list of revenue-raising tax changes that the staff had collected over the years.

Melling added, however, that the amount of tax owed by the majority of the 88% who are non-compliers is relatively small, and it most likely would cost the IRS more to pursue collection efforts against them than any tax revenue eventually collected. The IRS might nevertheless go after these non-compliers for non-revenue-raising reasons, such as promoting tax fairness and equity.

The crypto tax evasion that is costing the IRS the most money comes from wealthier investors who are more sophisticated at hiding their transactions, using decentralized exchanges rather than centralized exchanges such as Coinbase. The IRS will have a more difficult time pursuing them and collecting taxes that may be due, though it has announced its intention to go after them as well.

For the moment, however, cryptocurrencies are riding high. Bitcoin has soared since the election and now trades for more than $100,000 each-up over 100% over the last 12 months. Crypto investors therefore own an enormous amount of unrealized capital gains, and many will be tempted to realize those gains-and thereby create a taxable event.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

-Mark Hulbert

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January 27, 2025 14:29 ET (19:29 GMT)

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