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The Internal Revenue Service may be missing out on more than $50 billion a year from crypto traders not paying their taxes. And the agency is taking notice.
In a new analysis released by Barclays last week, managing director Joseph Abate estimated that the tax gap from crypto trades — the difference between how much tax revenue the IRS collects and how much it is owed — may be as much as $50 billion per year.
Barclays made its calculation by extrapolating data referenced by the IRS in 2017 to estimate that the current crypto tax gap represents a full 10% of the overall national tax gap.
However, the gap is likely much larger, according to Barclays. That's because "much of the DeFi activity occurring today did not exist four years ago." DeFi, which stands for decentralized finance, aims to recreate traditional financial systems, such as banks and exchanges, with cryptocurrency. Most run on the Ethereum blockchain.
"While all transactions may be visible on the blockchains, if all the counterparties are anonymous, it is difficult for the IRS to figure out who owes taxes," Abate writes. "Without any supporting IRS data, our sense is that the $50 billion estimate for the crypto tax gap is probably too small."
This isn't to say that crypto traders should try to get away with not paying taxes on their gains. Instead, they should be more diligent than ever in reporting, as the IRS has greatly increased its crackdown on would-be crypto tax evaders in recent years.
"The IRS has been leaning very hard, investing in both personnel as well as process and form amendments," says Austin Woodward, a certified public accountant and CEO of crypto accounting platform TaxBit.
For the past two years, the first item that taxpayers have encountered on their 1040 forms after filling out their contact information is a question asking if "at any time during 2021, did [they] receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency," which taxpayers must answer under penalty of perjury.
"If you answer 'no' and don't report your crypto gains, now, there's intent behind this willful negligence," Woodward tells CNBC Make It. Failing to report gains could result in a lengthy IRS audit and possible fines.
The best course of action for crypto traders is to be upfront and honest on their taxes about the crypto purchases and sales they make in a given year. Because the IRS audits on a two-year lag, Woodward says that traders who failed to report gains in the past may still get caught.
He recommends keeping detailed records of your transactions so that you can answer any questions the agency may have for you. If you need to amend a previous tax return, you can do so electronically with the IRS at this link.
"I think the best approach for any cryptocurrency user is to act like it's not anonymous at all," he says. "Just because you feel like you're safe and in the clear a few months after you file your tax return, that is not the case. This thing can linger on for many, many years."