The rapid expansion of cryptocurrency over the past decade has revolutionized financial transactions, but it has also attracted increased crypto regulatory scrutiny from agencies like the IRS (Internal Revenue Service) and FinCEN (Financial Crimes Enforcement Network). As crypto transactions become mainstream, regulators examine businesses and investors more closely. Failing to comply with evolving regulations can lead to severe financial penalties.
This blog will talk about the function of the IRS and FinCEN in cryptocurrency investigations, how these investigations impact crypto businesses, and steps you can take to ensure compliance. Understanding the regulatory landscape is critical for the success of your crypto business, and understanding these laws will help you avoid costly mistakes while staying in line with tax and financial crime regulations.
The IRS and Cryptocurrency: A Growing Focus on Tax Compliance
IRS Reporting Requirements
The IRS has become more aggressive in enforcing cryptocurrency tax compliance, particularly with the upcoming 2025 requirement for brokers to report transactions like sales and exchanges, which will enhance oversight. Cryptocurrencies are classified as property, not cash, for federal tax purposes, meaning transactions—whether buying, selling, or gifting—are subject to capital gains taxes. However, the decentralized nature of cryptocurrencies makes it difficult to track transactions, leading many taxpayers to underreport their crypto income or gains.
To address this, the IRS requires taxpayers to report crypto transactions on their tax returns using forms like Form 1040 and Form 8949. Despite these guidelines, many individuals and businesses fail to comply with reporting requirements. As a result, the IRS has ramped up enforcement efforts, and noncompliance can result in severe penalties for taxpayers who don't accurately report their cryptocurrency holdings.
Increased Penalties and Scrutiny
The IRS is actively enforcing cryptocurrency reporting requirements and imposing penalties for non-compliance, especially for investors who fail to report gains or income accurately. These penalties can quickly escalate, particularly for significant transactions. The IRS has made cryptocurrency a high-priority area and uses methods like subpoenas to track transactions, as seen in the 2016 Coinbase case, where the IRS obtained customer data for users with transactions over $20,000.
Crypto businesses involved in mining or staking must ensure they keep detailed records of earnings and comply with tax reporting requirements to evade penalties. The IRS strongly focuses on such activities, and failure to report them correctly could lead to increased audits or investigations, further emphasizing the importance of strict compliance.
The Rise of the New Cryptocurrency Reporting Form
The IRS has introduced a new reporting requirement with Form 1099-DA, which is set to go into effect in 2025. This form requires brokers and digital asset exchanges to report the proceeds from customer cryptocurrency transactions. As cryptocurrency exchanges increasingly adopt this reporting framework, crypto businesses must be ready to comply with these enhanced reporting requirements. Failing to manage your reporting systems properly can expose you to penalties and damage your reputation as a trustworthy crypto business.
FinCEN's Role in Regulating Cryptocurrency
FinCEN, a bureau of the U.S. Treasury Department, focuses on enforcing anti-money laundering (AML) regulations and battling financial crimes, such as money laundering and terrorist financing. While the IRS is concerned with tax compliance, FinCEN investigates illicit financial activities. In 2023, FinCEN designated "mixing transactions" involving cryptocurrency mixing services as a "Primary Money Laundering Concern," signaling a major regulatory shift.
This move imposes stricter compliance requirements on financial institutions and cryptocurrency businesses involved in such transactions. Mixing services, which obscure the origin and destination of cryptocurrency, make it harder to trace illicit activities. As a result, crypto businesses must be more vigilant in identifying and avoiding transactions that could be linked to money laundering under regulators' increased scrutiny.
Special Measure 1: Increased Compliance Burden
To combat the risks associated with cryptocurrency mixing, FinCEN has proposed implementing Special Measure 1, which would require entities involved in cryptocurrency transactions to report detailed information about the transactions, such as the type of cryptocurrency involved, the mixer used (if known), and the wallet addresses associated with the transactions. This proposal represents a significant expansion of FinCEN's authority, enabling the agency to track better and prevent illegal financial activities in the crypto space.
Under this measure, businesses would be required to maintain and report more comprehensive records for each transaction. These records include the customer's full name, birthdate, contact information, and other identifying data. As a result, cryptocurrency exchanges and businesses that engage in crypto transactions must invest in robust compliance programs and technologies to meet these reporting requirements.
The Impact of FinCEN Investigations on Crypto Businesses
FinCEN investigations can lead to severe consequences for crypto businesses found to be involved in illicit activities. The agency has the authority to impose significant fines and penalties on businesses that fail to comply with AML regulations. If a cryptocurrency exchange or wallet provider is found to be enabling money laundering or other illegal activities, it could face hefty fines, and in some cases, even criminal charges.
In addition to financial penalties, a business's reputation could be severely damaged if it becomes embroiled in a FinCEN investigation. Trust is essential in the cryptocurrency industry, and negative publicity resulting from regulatory noncompliance can lead to the loss of customers and partnerships. Crypto businesses must, therefore, be proactive in implementing and maintaining effective regulatory compliance measures to avoid falling under FinCEN's scrutiny.
Best Practices for Crypto Businesses
To avoid falling victim to IRS or FinCEN investigations, crypto businesses must take proactive steps to ensure compliance with the applicable tax and financial crime regulations. Here are some key best practices for maintaining compliance:
- Maintain Detailed Records: Ensure all transactions, including buys, sells, and transfers, are adequately documented. This includes recording the date, value in U.S. dollars, and purpose of each cryptocurrency transaction. The IRS requires this level of detail to accurately assess capital gains and losses.
- Develop a Robust Anti-Money Laundering (AML) Program: comprehensive AML program is essential to prevent your business from being linked to money laundering activities. This includes customer verification, transaction monitoring, and regular compliance audits. You must be especially vigilant if your business deals with high-risk activities, such as mixing services or cross-border transactions.
- Comply with Reporting Requirements: Stay up to date with the IRS's reporting requirements, including the upcoming Form 1099-DA for cryptocurrency transactions. Ensure that your systems are equipped to handle the required reporting and that you are prepared to submit accurate information.
- Work with Compliance Experts: Cryptocurrency laws are complex and constantly evolving. Enlisting the help of legal and compliance professionals who specialize in cryptocurrency law can ensure that your business remains on the right side of the law.
The Role of Legal Advisors in Crypto Compliance
As cryptocurrency regulations continue to evolve, businesses in the crypto space face increasing challenges in staying compliant. For businesses based in California or those dealing with California residents, it is highly advisable to consult with a cryptocurrency lawyer in California. Legal experts can help you navigate the complexities of both state and federal regulations, including the Fintech And Cryptocurrency Business.
At Bulldog Law, we specialize in providing legal counsel to cryptocurrency businesses in California, helping them ensure full compliance with both tax and financial crime laws. With the regulatory landscape shifting rapidly, having a trusted legal partner on your side can make all the difference in ensuring the continued success of your crypto business.