As cryptocurrency trading and investment becomes more mainstream, the IRS has been ramping up efforts to track and perfect civil and criminal tax enforcement efforts surrounding digital assets. Many taxpayers assume that cryptocurrency remains off the government’s radar, but recent civil and criminal enforcement efforts dictate otherwise. The IRS has issued John Doe Summons to several major cryptocurrency exchanges, enhanced its data analytics processes, and forged partnerships with third-party tech firms to identify non-compliant taxpayers. At the Tax Law Offices of David W. Klasing, we often advise taxpayers on their cryptocurrency tax obligations, ensuring they understand how to accurately report digital asset transactions, how to be prepared for a cryptocurrency focused audit or criminal tax investigation, and what can happen if they fail to do so.
Understanding Cryptocurrency Taxation
In the United States, cryptocurrencies such as Bitcoin, Ethereum, and various “altcoins” are generally treated as property for federal tax purposes. This means that every time you sell, exchange, or use cryptocurrency to purchase goods or services, you have a taxable event. The gain or loss is typically the difference between what you paid (the basis) and the fair market value at the time of sale or exchange.
The IRS expects taxpayers to meticulously track these transactions, which can be mind boggling complicated if you’re actively day trading via algorithm, an exchange you’re trading on gets hacked or goes bankrupt, you’re using multiple wallets and exchanges, or lose a wallet.
If you hold cryptocurrencies for investment, you must report gains or losses on Schedule D of your personal tax return. If you’re mining or staking coins, the reward is usually recognized as ordinary income subject to self-employment tax at the fair market value on the day you receive the coins.
What Constitutes Tax Evasion in Relation to Crypto?
Tax evasion goes beyond innocent mistakes. The IRS typically attempts to gather evidence that shows a taxpayer’s willful intent to underreport or hide cryptocurrency income in audits & criminal tax investigations. With cryptocurrency, this can occur where a taxpayer consistently fails to report taxable transactions, deliberately understates cryptocurrency based taxable income, deliberately overstates their basis in cryptocurrency or deliberately disguises the flow of funds surrounding cryptocurrency transactions. Examples of cryptocurrency badges of fraud include using mixing services to obfuscate the origin of coins or transferring digital assets into shell companies or offshore accounts to conceal beneficial ownership.
While the IRS is aware that some taxpayers may be confused about how to report cryptocurrency transactions, mere confusion is not a defense if the government can prove intentional wrongdoing. Even if you initially underreported due to lack of knowledge, ignoring subsequent opportunities to correct your filings could be interpreted as willful evasion.
Tax evasion involves willfully attempting to evade or defeat a tax. In the crypto world, the IRS typically looks for evidence of:
Consistent Underreporting or Non-Reporting
Failing to disclose frequent or substantial taxable crypto events, such as trades, mining rewards, or sales.
Overstating Basis
Artificially inflating your cost basis to minimize or eliminate taxable gains.
Using Obscuring Techniques
Leveraging “mixers,” “tumblers,” or shell companies—potentially offshore—to hide the origin of coins or beneficial ownership.
Structuring or Fragmenting Transactions
Splitting large amounts into smaller, less-detectable transfers, especially across multiple wallets or exchanges.
Ignoring Corrective Opportunities
Persistently refusing to amend returns or disclose crypto holdings after IRS notices or warnings is a strong badge of fraud.
Even if confusion caused initial mistakes, that defense weakens significantly if you ignore subsequent chances to become compliant—an action the government can view as willful evasion. The Supreme Court allows the willfulness requirement to be inferred from “any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
Why the IRS is Focused on Cryptocurrency
From a government standpoint, cryptocurrency offers new challenges for tax compliance, given the pseudo-anonymity and decentralization features of many digital currencies. However, as more people use cryptocurrency for both investment and everyday transactions, the potential for underreporting increases. The IRS and other agencies view unreported cryptocurrency transactions as a growing threat to tax revenues. Consequently, they’ve stepped up enforcement with specialized training for agents and advanced software tools capable of analyzing blockchain data.
Heightened IRS Enforcement
Ongoing IRS Initiatives:
- John Doe Summonses: Major exchanges such as Coinbase, Kraken, and others have received broad requests from the IRS seeking user account data, making it more difficult for taxpayers to conceal their crypto transactions.
- Advanced Analytics: The IRS has forged partnerships with specialized tech firms to trace transactions across multiple blockchains, undermining the perceived anonymity of many digital assets.
- Operation Hidden Treasure: A targeted initiative focusing on unreported cryptocurrency transactions, using sophisticated chain-analysis techniques to detect patterns of fraud or omission.
Cryptocurrency Taxation and Audit Risk Exposure
This landmark case underscores how many individuals dealing with digital assets often underestimate the catastrophic outcomes of a high-risk eggshell audit, reverse eggshell audit, or full-blown IRS criminal tax investigation. When the sole alleged offense is criminal tax noncompliance, the government’s willingness to seek imprisonment should serve as a sobering warning: fast, strategic damage control is critical the moment you suspect you’re under IRS scrutiny.
John Doe Summonses and High-Risk Letters: The IRS Casts a Wider Net
Buoyed by successes like the Ahlgren conviction, the IRS and DOJ have signaled that “more is coming.” A primary tool now involves John Doe Summonses, which compel major crypto exchanges (e.g., SFOX, Kraken, Coinbase) to disclose user data for those transacting above specific thresholds—sometimes as little as $20,000 over several years. By obtaining sweeping exchange records, the IRS aims to identify taxpayers who have significantly underreported their digital asset gains. Courts have repeatedly demonstrated a readiness to approve these broad-scope summonses, bolstering the government’s reach into transactions once assumed untraceable.
Simultaneously, the IRS issues “high-risk” letters to taxpayers believed to be significantly underreporting their crypto-related activities—often as part of Operation Hidden Treasure, where civil and criminal tax enforcement divisions collaborate to unearth crypto tax fraud. Agents employ sophisticated blockchain analytics to track mixers, private wallets, and structured sub-$10,000 transfers, all of which once appeared to afford anonymity. The elevated capabilities of federal investigators show that taxpayers who attempt to hide digital profits now face potentially devastating civil and criminal tax consequences.
Taxpayers who suspect they may have misreported or entirely failed to report cryptocurrency income are strongly encouraged to act quickly—before receiving a subpoena, a John Doe Summons, or a “high-risk” IRS notice. Voluntarily coming forward—whether through a formal voluntary disclosure or by carefully amending returns under the guidance of a seasoned dual-licensed cryptocurrency tax attorney and CPA—can help mitigate both civil and criminal tax penalties. In contrast, waiting for the IRS to initiate an audit typically results in more considerable fines, prolonged investigations, and, as the Ahlgren case demonstrates, the potential for federal criminal tax prosecution and subsequent imprisonment. Call us at (800) 681-1295 or reach out online to schedule a reduced-rate initial consultation.
Civil Penalties
Accuracy-Related Penalties
A common penalty for underreporting income is the accuracy-related penalty, which generally amounts to 20% of the underpayment. If the government concludes that the underreporting is due to negligence or a disregard of the rules, you may face this penalty in addition to owing back taxes and interest.
Civil Tax Fraud Penalties
If the IRS concludes that fraud was involved, it can impose a civil fraud penalty equal to 75% of the underpayment. This is a severe penalty, often used when there’s clear evidence of intentional misrepresentation or concealment. The most dangerous part of this penalty is if the government has the evidence to assert the civil fraud penalty, it has the evidence to criminally prosecute a tax crime.
Late Filing/Payment & Other Penalties
Failing to file by the deadline or neglecting to pay taxes can bring additional fines, often calculated as a percentage of unpaid taxes per month. Furthermore, taxpayers who hold digital assets on foreign exchanges and meet certain thresholds may face FBAR or FATCA penalties if they fail to disclose accounts via FinCEN Form 114 or Form 8938.
Criminal Tax Penalties
Taxpayers who engage in deliberate cryptocurrency tax evasion risk criminal tax prosecution by the Department of Justice. Potential charges include filing false returns, tax evasion, and conspiracy to defraud the government. Convictions can result in fines, restitution, and even prison sentences. The stigma of a criminal tax conviction can haunt individuals long after fines are paid, affecting professional licenses, career opportunities, and personal relationships.
In recent years, the IRS has launched Operation Hidden Treasure, a program specifically aimed at rooting out taxpayers who fail to report cryptocurrency gains. Investigations often involve tracing transactions across multiple blockchains, working with foreign jurisdictions, and subpoenaing exchange records. The mere existence of this initiative underscores the level of scrutiny aimed at digital assets.
If the IRS determines that your cryptocurrency noncompliance was deliberate, its clandestine criminal investigation division can refer your case to the DOJ for criminal tax prosecution under various statutes—even beyond any substantial civil fines you might already face. Prosecutors must prove that you knowingly and intentionally acted dishonestly on your tax returns rather than simply making an innocent error or miscalculation.
- Tax Evasion (26 U.S.C. § 7201)
- Punishable by up to 5 years in prison and fines that can reach $250,000 for individuals.
- Requires willful intent to evade or defeat a tax.
- Filing a False or Fraudulent Return (26 U.S.C. §§ 7206(1), 7207)
- May lead to up to 3 years (under § 7206) or up to 1 year (under § 7207) in prison, plus criminal fines.
- Even underreporting crypto gains that the government classifies as “material” can result in these charges if intent to deceive is shown.
- Conspiracy to Defraud (18 U.S.C. § 371)
- Up to 5 years in prison and hefty fines if you collaborate with others—such as accountants, advisors, or business partners—to hide crypto income or otherwise defraud the government.
- Potential Money Laundering or Other Financial Crimes
- Large-scale or structured cryptocurrency transactions may draw scrutiny under broader financial crime statutes, potentially adding more jail time, penalties, or asset forfeitures.
It is crucial to remember that genuine mistakes—like minor computational errors or using the wrong form—do not meet the threshold for criminal tax charges. Similarly, simply being unable to pay your tax liability is not a criminal offense if you can legitimately demonstrate financial hardship. However, once you are investigated for suspected tax fraud, consulting an experienced attorney immediately is paramount to building a robust defense and minimizing risks.
If found guilty of tax fraud in a cryptocurrency context, sentences can range from additional fines to up to five years in prison. Because the IRS views rigorous enforcement of crypto compliance as vital to upholding the tax system’s integrity, prosecutors often seek severe punishments in serious cases to deter others from engaging in similar misconduct.
Landmark Criminal Tax Evasion Conviction Centered on Cryptocurrency
In a significant enforcement milestone, the IRS and the DOJ obtained what is regarded as the first criminal tax evasion conviction exclusively targeting cryptocurrency-based noncompliance. The defendant, Frank Richard Ahlgren III of Austin, Texas, received a two-year federal prison sentence and was ordered to pay over $1 million in restitution after willfully underreporting gains from selling roughly $4 million in Bitcoin. Ahlgren began buying Bitcoin in 2011, allegedly inflated his cost basis to minimize taxable income on his 2017 return, and then failed to report an additional $650,000 in Bitcoin proceeds over the next two years. Acting Special Agent in Charge Lucy Tan of IRS Criminal Investigation’s Houston Field Office emphasized that this marks the first purely tax-focused crypto prosecution—without other financial crimes such as money laundering—clearly demonstrating that digital-asset infractions alone can lead to prison time and life-altering repercussions.
How the Tax Law Offices of David W. Klasing Can Help
Given the complexity of cryptocurrency tax rules—and the harsh penalties for getting it wrong—seeking professional guidance is crucial. At the Tax Law Offices of David W. Klasing, we offer a comprehensive approach, drawing on our dual expertise in law and accounting. We can help you:
- Review your transaction history across wallets and exchanges to identify potential compliance gaps,
- Develop strategies for correctly reporting past trades, staking rewards, and mining income,
- Pursue voluntary disclosure if you’ve underreported cryptocurrency activity in previous tax returns, and
- Represent you in cryptocurrency based audits or criminal tax investigations, responding to an IRS letter regarding your allegedly unreported cryptocurrency transactions, ensuring that you receive fair treatment and that your constitutional taxpayer rights are protected.
Whether you’ve been trading digital assets for years or are just getting started, the IRS’s focus on cryptocurrency taxation means any oversights could be costly. Sometimes, taxpayers learn they’ve made filing mistakes only after receiving an audit notice or a letter requesting more information. Addressing the issue proactively is usually less stressful and can result in reduced penalties compared to responding under pressure.
Taking Proactive Steps
With the 2024 revisions to the IRS Voluntary Disclosure Program, taxpayers should be aware that Form 14457 now implements a two-step preclearance and disclosure process, requires taxpayers to sign under penalties of perjury, and obliges them to affirmatively acknowledge willfulness—effectively providing the government with a “written confession.” Under current practice, a six-year disclosure period is usually demanded in income tax cases, a civil examination is mandatory (including the possibility of a confrontational interview), and direct requests for administrative appeals are no longer available once you enter the VDP. Taxpayers generally must settle all taxes, interest, and penalties in full or arrange for an installment agreement, as the updated VDP virtually eliminates Offers in Compromise or partial-pay options. Declining to cooperate with the examiner, challenging penalty determinations, or failing to adhere to these revised procedures can result in expulsion from the program, thereby exposing taxpayers to the criminal tax prosecution they sought to avoid.
Note: As long as a taxpayer who has willfully committed tax crimes—potentially including unfiled foreign information returns or undisclosed cryptocurrency income combined with affirmative evasion of U.S. income tax on offshore income—self-reports the tax fraud (including any history of unfiled returns) through a domestic or offshore voluntary disclosure before the IRS initiates an audit or criminal tax investigation/prosecution, that taxpayer can typically be returned to tax compliance with a near-guaranteed pass on criminal tax prosecution and, in many cases, secure a reduction of the civil penalties that would otherwise apply.
The best defense against penalties for cryptocurrency tax evasion is proper record-keeping and timely filing. If you’re unsure about your filing obligations, this is the moment to consult with a tax lawyer who understands the nuances of digital assets. Even if you realize you made mistakes, or willfully cheated in earlier tax filings, correcting them now often places you in a better position than waiting for the IRS to initiate contact.
At the Tax Law Offices of David W. Klasing, we strive to provide clear, tailored advice so that you can continue to invest and trade in digital currencies without the specter of potential criminal or civil penalties hanging over you. We serve clients across the country, assisting in federal tax matters. Our goal is to help you stay compliant, avoid unnecessary complications, and protect your financial future.
Moreover, only an attorney can initiate a voluntary disclosure without engaging in the unauthorized practice of law (itself a criminal offense). An attorney trained in Criminal Tax Defense thoroughly understands the risks and benefits of voluntary disclosures—particularly under this newly stringent framework—and how to protect your interests if you do not qualify for a voluntary disclosure or if your case becomes contentious during the examination.
As dual-licensed Criminal Tax Defense Attorneys and Kovel CPAs with extensive experience, the Tax Law Offices of David W. Klasing provides a one-stop solution to efficiently attain optimal and predictable outcomes while safeguarding both your freedom and your net worth. Be sure to read our Testimonials to see what clients say about us!
If you have questions about cryptocurrency taxation or believe you may have underreported your digital asset transactions, contact us to explore your options. A knowledgeable Tax Attorney-CPA can mean the difference between a manageable resolution and a devastating legal battle followed by life altering consequences including incarceration.
