18 Sep 23

Warning Signs the IRS Could Accuse You of Using Cryptocurrency to Launder Money

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Last Updated on: 19th September 2023, 04:08 am

Warning Signs the IRS Could Accuse You of Using Cryptocurrency to Launder Money

Cryptocurrency like Bitcoin and Ethereum has exploded in popularity in recent years. Many people are attracted to the potential for high returns from trading and investing in digital assets. However, cryptocurrency also has potential for abuse by criminals looking to launder money.

If you trade or invest in crypto, you need to be aware of steps you can take to avoid raising red flags with the IRS that could lead to accusations of money laundering. This article will cover warning signs to watch out for and steps you can take to trade crypto legally and safely.

What is Money Laundering?

Money laundering involves taking “dirty” money gained from criminal activities and processing it through legitimate businesses to make it appear “clean.” Money laundering allows criminals to enjoy financial gains from crimes while evading law enforcement.

Common money laundering techniques include:

  • Structuring cash deposits to avoid reporting requirements
  • “Smurfing” – spreading deposits across multiple accounts
  • Using shell companies to disguise ownership
  • Mixing clean and dirty money through cash businesses

The rise of cryptocurrency has opened new avenues for laundering money. Criminals can use crypto to quickly move funds globally and obscure ownership. However, the transparency of blockchains also allows law enforcement to trace funds.

How the IRS Investigates Crypto Money Laundering

The IRS treats cryptocurrencies like property for tax purposes. This means you owe taxes on any gains from selling or trading crypto. Failing to report crypto activity can raise suspicions of tax evasion or money laundering.

The IRS Criminal Investigation division partners with other agencies like the Department of Justice to build cases against crypto tax evaders and money launderers. Tactics they use include:

  • Obtaining records from crypto exchanges to trace transactions
  • Analyzing blockchain ledgers to follow money flows
  • Undercover operations targeting crypto money laundering services
  • Working with global partners to uncover cross-border laundering

Two major arrests in February 2022 targeted an alleged conspiracy to launder $4.5 billion in stolen cryptocurrency. This demonstrates the scale of money laundering crypto investigations.

Warning Signs That Could Trigger an IRS Investigation

Certain patterns of crypto activity can raise red flags with the IRS and trigger investigations, audits, or criminal charges. Warning signs include:

  • Failing to report crypto gains on taxes
  • Reporting income that doesn’t match crypto holdings
  • Cashing out large crypto gains piecemeal to avoid reporting thresholds
  • Frequent crypto transactions with no clear business purpose
  • Moving crypto between wallets or exchanges in a way that obscures ownership
  • Converting large amounts of crypto back to cash
  • Using mixers and tumblers to anonymize crypto transactions
  • Transacting with darknet markets or other suspicious sources of crypto

The IRS even offers rewards to whistleblowers who provide information about tax evasion involving cryptocurrency. If you come across suspicious activity in your crypto circles, it’s wise to steer clear.

Avoiding Money Laundering Accusations

If you want to avoid legal issues when trading crypto, here are some best practices to follow:

  • Report all crypto gains and losses on your taxes every year
  • Keep detailed records of your crypto cost basis, purchases, sales, trades, mining income, airdrops, gifts, etc.
  • Only use reputable, regulated exchanges and wallets
  • Never transact with darknet markets, unregulated gambling sites, or other shady sources of crypto
  • Avoid unnecessary wallet-to-wallet transfers that obscure ownership
  • Don’t attempt to conceal crypto activity (for example, using mixers)
  • Consult a tax professional if you have questions about crypto reporting

Following these guidelines helps show the IRS you are making a good faith effort to comply with tax laws. However, because crypto tax rules are complex, innocent mistakes can still occur. Working with an experienced tax attorney can help you build a strong case if you end up facing an audit or investigation.

Penalties for Crypto Money Laundering and Tax Evasion

If convicted of money laundering or tax evasion related to cryptocurrency, penalties can be severe:

  • Up to 20 years in prison for money laundering
  • Up to 5 years for tax evasion
  • Fines up to $250,000 for individuals or $500,000 for corporations
  • Forfeiture of assets involved in money laundering
  • Court-ordered payment of back taxes, interest, and penalties

These criminal charges can ruin finances and reputation, even if the activity was unintentional. That’s why it’s so important to consult experienced legal counsel if you come under investigation.

Protect Yourself When Trading Crypto

With sound tax planning and record keeping, cryptocurrency can be traded legally and safely. However, crypto is also used to enable financial crimes like money laundering and tax evasion. By understanding the warning signs that can trigger IRS scrutiny, you can take proactive steps to avoid accusations.

If you receive an audit notice or become aware you are under investigation, don’t panic. Here are some steps to take:

  • Respond to the notice promptly and by the deadline stated. Ignoring an IRS audit will only make things worse.
  • Gather any records needed to support your tax return, such as receipts, invoices, bank statements, and documentation of crypto transactions.
  • Consider hiring a tax professional or attorney experienced in crypto cases to represent you.
  • Be cooperative with IRS agents and answer questions truthfully, but don’t volunteer extra information.
  • Ask the IRS to explain the specific issues they have with your return and focus responses on those areas.
  • If errors are identified, work constructively to calculate the correct tax liability.
  • Negotiate with the IRS if additional tax is owed. Payment plans or settlements may be available.
  • If you disagree with the audit findings, you can provide additional documentation or file an appeal.
  • Avoid aggressive behavior, which can reinforce suspicions. Stay calm and professional.

The IRS prioritizes audits that are likely to uncover tax evasion or money laundering. However, innocent mistakes can also trigger investigations. By responding promptly and providing complete records, you have the best chance of resolving an audit with minimal penalties.

If criminal charges are pursued, immediately consult with a tax attorney experienced in crypto cases. An experienced attorney can negotiate with prosecutors to dismiss unfounded charges or reduce penalties if misconduct did occur. Don’t attempt to handle a criminal investigation without legal counsel.