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Why It’s Harder Than Ever to Hide Your Crypto From the Taxman

Last Updated October 18, 2023 10:36 PM
Josh Adams
Last Updated October 18, 2023 10:36 PM
Key Takeaways
  • Cryptocurrency used to be a technology shrouded in mystery. Not anymore.
  • Governments are spending more resources than ever monitoring blockchains.
  • As their efforts increase, the chances of being caught for tax evasion rises, too.

In the first few years after cryptocurrency arrived on the scene, paying tax on your gains felt optional, even if legally it wasn’t. Frankly, at the time, very few people in government and law enforcement either knew what it was or where to look.

However, in 2023, that landscape has changed completely. Governments are not only aware of cryptocurrency but are actively monitoring blockchains in an attempt to recoup billions for their treasuries. After years, the digital financial behavior of thousands could well be coming to light.

Governments Really Want Your Crypto Taxes

With crypto’s public ledger, governments can “trace transfers to identify wallet owners,” explains David Lesperance of tax and immigration law firm Lesperance and Associates. But officials must sift through massive amounts of data to pinpoint targets.

But how do they manage the firehose of data coming their way? Lesperance likens tracking cryptocurrency to his experience in search and rescue with the Canadian Coast Guard. Just as locating vessels requires triangulating signals, officials can trace cryptocurrency transfers to identify specific individuals.

Governments have ample reasons to invest in blockchain analysis, but especially to boost tax revenue. Most large economies, including the US and UK, have either partnered with blockchain intelligence firms or hired their own  experts—but usually both. 

“Tax authorities, whether that’s HMRC or the IRS or you know, SARS in South Africa or CRA in Canada—it’s the only government agency that’s actually a revenue generator,” explained Lesperance. 

Jurisdictions are also passing legislation to move the burden of compliance towards crypto businesses themselves. On October 17, the European Union adopted new tax transparency rules requiring crypto-asset service providers to report transactions for EU residents. Another way to get caught in the net.

New rules  proposed by the IRS have also caused much alarm, with Coinbase calling them “an unprecedented, unchecked, and unlimited tracking on the daily lives of Americans.” Other jurisdictions are likely to follow suit with similarly tough measures.

Watch How You Spend Your Crypto

Lifestyle audits present another avenue for exposing crypto tax evaders or criminals. Lesperance gives the example: “If you’re unemployed but have a Lamborghini in your driveway, how did that happen?” Lavish spending can raise red flags, prompting audits .

Since 2020, the IRS  has included a cryptocurrency question  on its declaration forms. Yet Lesperance says comparing tax returns to bankrupt exchanges’ creditor lists can uncover false answers. For instance, an individual denying crypto ownership despite appearing as a creditor of FTX  or Celsius—for example—enables prosecution for tax evasion.

To illustrate the precarious position of bigger crypto criminals, Lesperance references the film GoodFellas, starring Robert DeNiro.

Mobsters robbed millions but couldn’t spend it without attracting police attention. Like those gangsters, crypto criminals may possess fortunes in their wallets but remain unable to use the funds without getting caught. With unlimited time and resources, authorities can simply wait for a slip-up.

Taxpayer’s Responsibility to Prove Innocence

But most aren’t people aren’t GoodFellas’ level of rich, or criminal. And if some statistics are to be believed, most are getting away with their tax evasion, too. One report  from Swedish tax firm Divly, published on April 5, appears to show that only a very small minority of crypto holders pay tax on their digital assets. 

According to its research, only 1.62% of crypto holders in the United States fulfilled their legal requirements. Finland and Australia came to the top of the league table with only 4.09% and 3.65%, respectively. 

However, the study’s methodology raises serious doubts. Divly claims it uses a mix of official government figures, and available cryptocurrency ownership data, on top of making considerable assumptions about search data.

But even if the figures are true, it doesn’t mean tax evaders have got off scot-free. Unlike cash, crypto’s transparency allows precise tracking. It’s “like shooting fish in a barrel.”

“The nice thing about crypto is that you can actually trace it really easily whereas cash is just a lot more difficult,” said Lesperance

Let’s not forget either that tax bills can also be applied retroactively. And if or when the taxman comes calling, they won’t have to rely on “beyond a reasonable doubt” for a conviction. “The onus is on the taxpayer to prove that they’re not liable,” Lesperance explained emphatically. “[And] that’s in all jurisdictions.”

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