The IRS began issuing guidance on taxation of Bitcoin in March 2014. At that time, the agency announced that Bitcoin would be treated as property, with loss or gains being treated as capital loss or capital gains for tax purposes.
Readers are probably familiar with the many “rags-to-riches” stories about Bitcoin investors becoming millionaires almost overnight. Such stories abound, from the Idaho teenager who turned $1,000 into $1.1 mln and the Norwegian engineer who made $800,000 in profit off a $24 investment.
None of these stories mention the taxes these individuals paid...or didn’t pay.
Given Bitcoin’s crypto-anarchist roots, it’s perhaps not surprising that some seem to take the idea of taxation lightly. Many believe that since Bitcoin is pseudo-anonymous, there’s no way the IRS will find out about their taxable gains. Yet they may be wrong.
Bitcoin isn’t as anonymous as many think, as evidenced by the number of people in federal prison who paid in Bitcoin for child pornography or illegal drugs. There are a number of companies that scour the Blockchain, seeking to link Bitcoin accounts to their actual owners.
Earlier this month, the IRS was found to have been partnering with a company called Chainalysis to double down on its efforts to monitor Bitcoin traders who engage in high frequency and volume trading.
The IRS has recently been focusing on Coinbase, demanding that the exchange reveal the identity of anybody who traded more than $20,000 in Bitcoin per year between 2013 and 2015. The IRS is probably correct in their belief that many Bitcoin owners are evading taxes. In the year 2015, only 802 Americans told the IRS about their Bitcoin-related capital gains or losses, according to Fortune.
How can Chainalysis help IRS?
Founded in 2014, Chainalysis is an anti-money laundering software for Bitcoin. Through its formal partnerships with Europol and other international law enforcement agencies, Chainalysis’ investigative tools have been “used globally to successfully track, apprehend, and convict money launderers and cybercriminals.”
It’s important to remember that Bitcoin’s Blockchain is, by its very nature, totally transparent. Every transaction that has ever occurred is listed in that decentralized ledger, and transactions can be followed through the Blockchain using sophisticated software. The only thing that gives Bitcoin any semblance of privacy is the fact that it uses random addresses which are not necessarily associated with a user’s real-world identity.
It’s wise to remember, though, that people leak information about themselves all the time. Many people even publicly post their Bitcoin address on Internet forums. If they were to turn around and use this same address, or one associated with it, for illegal activity then their identity could be unmasked.
Given that 2017 has been a banner year for cryptocurrencies, it wouldn’t be surprising to see Bitcoin and other digital currencies high on the IRS’ list of priorities.