What Triggers IRS Criminal Investigations and Prosecution for Cryptocurrency Tax Evasion?

The IRS has been ramping up efforts to crack down on cryptocurrency tax evasion. With crypto becoming more mainstream, the IRS Criminal Investigation division (IRS CI) has been aggressively pursuing criminal cases against crypto investors and traders who fail to properly report crypto transactions on their taxes.

But what exactly triggers the IRS to open up a criminal investigation into potential cryptocurrency tax evasion? When does tax avoidance cross the line into willful illegal tax evasion? I did some digging into recent IRS criminal enforcement actions against crypto users to find out.

Failing to Report Crypto Income

One of the biggest red flags is simply not reporting your cryptocurrency income and gains at all on your tax return. In September 2022, a Florida man was convicted of tax evasion for failing to report over $5 million in bitcoin income on his taxes from 2016-2018 [1]. He now faces up to five years in prison.

The IRS is getting better at uncovering unreported crypto income and transactions. In the Florida case, IRS CI used blockchain analysis tools to trace bitcoin transactions from illegal dark web marketplaces like Silk Road to the defendant’s personal crypto wallets. The IRS can see when crypto enters your wallet, even if you try to obscure transactions through mixers and tumblers.

Using Crypto to Facilitate Crimes

If the IRS suspects you of using cryptocurrency to facilitate illegal activity or tax evasion schemes, you can bet they will investigate. In September 2022, IRS CI helped seize over $3 billion in stolen bitcoin connected to the Silk Road dark web marketplace – one of the largest seizures of cryptocurrency ever [2]. The DOJ has also brought charges this year against several individuals accused of crypto money laundering and fraud schemes involving over $100 million in intended losses [3].

The takeaway is that if the IRS suspects you are using crypto to enable illegal activity, they will leverage tools like blockchain analysis to build a tax evasion case against you.

Destroying Records

Another big trigger for criminal prosecution is destroying or concealing records relating to your crypto transactions. In January 2022, the CEO of a major crypto exchange was indicted for deleting files from his cell phone and computer [4]. He was charged with tax evasion, tampering with records, and obstruction of justice – serious felonies.

The IRS treats record destruction as a giant red flag. If you are being audited or investigated, do not delete any crypto transaction records or lie about your activities. Be honest and compliant to avoid obstruction charges.

Using Anonymizing Tools

The IRS is very suspicious of crypto users who take extensive steps to anonymize transactions. Tools like mixers, tumblers, and privacy coins like Monero seem designed to obscure transactions from the IRS. In fact, the 2022 IRS Criminal Investigation Annual Report specifically called out increased use of anonymizing tools as a major crypto tax evasion threat.

So tools that anonymize your crypto activity will likely raise scrutiny and prompt an IRS investigation to unravel the source of funds. The IRS has tech tools to analyze blockchain transactions, so don’t assume anonymity will prevent them from unmasking your crypto tax evasion.

Signs of Tax Protestor Beliefs

If the IRS detects signs you are a tax protestor who believes tax laws don’t apply to you, they will take your noncompliance very seriously. In June 2022, a crypto investor was sentenced to nearly 4 years in prison for tax evasion and obstructing the IRS, as well as displaying behavior of a tax protestor [5]. His sentence was harsher than average due to his ideological opposition to federal tax laws.

The IRS deals firmly with tax protestors who intentionally flout tax laws for ideological reasons. Don’t let anti-tax views lead you into a legal minefield.

Using Crypto to Evade Taxes

This should be obvious, but if the IRS believes you are willfully and intentionally using cryptocurrency to evade taxes, they will hit you with criminal charges. In 2021, a surgeon was sentenced to 1 year in prison for using crypto to hide millions in income offshore [6]. He knowingly used crypto to conceal income and avoid paying over $6 million in taxes.

The takeaway is that ignorance or negligence will not get you a pass. The IRS is looking for clear evidence you intentionally used crypto to conceal income, circumvent reporting requirements, and evade owing taxes.

Moving Crypto Offshore

If you transfer large amounts of crypto to offshore exchanges or wallets in known tax havens, the IRS will see that as a potential attempt to conceal assets. In the case of the Ohio surgeon using crypto to evade taxes, one factor that triggered IRS prosecution was him moving bitcoin to an offshore exchange [6].

Bottom line – moving crypto offshore to avoid US taxes is incredibly risky and may result in criminal prosecution. The IRS has tools to identify offshore crypto holdings.

Using Crypto to Avoid Reporting Cash Transactions

If the IRS believes you are using cryptocurrency as a means to avoid reporting requirements for cash transactions over $10,000, watch out. They can charge you with illegal structuring, money laundering, and other serious financial crimes.

For example, if you are conducting large cash business transactions and using crypto to stash cash offshore or avoid triggering cash transaction reports, you could face criminal tax charges or even RICO charges for ongoing criminal activity involving crypto.

Bottom Line on Crypto Tax Evasion Enforcement

With crypto under the microscope, the IRS is cracking down hard on intentional cryptocurrency tax evasion. Their criminal investigations division uses sophisticated blockchain analysis tools to uncover unreported crypto income and transactions.

If you failed to report crypto activity or took willful steps to hide crypto assets and evade taxes, seek legal counsel immediately. Hiring an experienced tax attorney proactively could help mitigate penalties and even avoid criminal prosecution.

The IRS is sending a clear message that crypto is not beyond the reach of tax laws. Those who use cryptocurrency as a tool for intentional tax evasion face serious criminal consequences from increasingly aggressive IRS criminal enforcement efforts.