Feb. 14, 2025

Is Your Digital Wallet Safe from the IRS?

Why is the IRS Eyeing Your Digital Wallet?

The world of finance is rapidly changing, and with the rise of digital wallets and cryptocurrencies, the IRS is taking notice. As faithful stewards of our finances, it's essential to understand why the IRS is interested in digital wallets and what it means for us, especially as Christians seeking to manage our money wisely and with integrity. This brings us to an important question: Is Your Digital Wallet Safe from the IRS?

Check out the full podcast episode:

The IRS and the Digital Economy

The IRS views digital assets, including cryptocurrencies, as property, not currency ¹. This distinction is crucial because it means these assets are subject to capital gains taxes when sold or exchanged for a profit ². Think of it like selling a piece of land or a valuable painting – if you make a profit, you'll likely owe taxes on that gain.

The IRS has been increasingly focused on ensuring that individuals and businesses accurately report their digital asset transactions ³. This includes income from various sources like:

Cryptocurrency Trading: Buying and selling cryptocurrencies can result in capital gains or losses, just like trading stocks ⁴.
Payments for Goods and Services: Receiving cryptocurrency as payment for goods or services is treated as ordinary income ⁴. Imagine a carpenter receiving Bitcoin as payment for building a bookshelf – that Bitcoin is considered income, just like a cash payment.
Mining and Staking: Rewards from mining and staking activities are also considered taxable income ⁵. It's like finding gold nuggets in a river – those nuggets have value and are subject to taxation.

The IRS defines digital assets as "any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology" ¹. This broad definition encompasses various forms of digital assets, including:

Convertible virtual currencies and cryptocurrencies: This category includes popular cryptocurrencies like Bitcoin and Ethereum, which can be exchanged for traditional currencies or used to purchase goods and services.
Stablecoins: These are cryptocurrencies designed to have a stable value, often pegged to a fiat currency like the US dollar.
Non-fungible tokens (NFTs): These unique digital assets represent ownership of a specific item or piece of content, such as digital art or collectibles.

The IRS has even introduced a question on your tax return asking if you engaged in any digital asset transactions during the tax year ⁶. This highlights the agency's commitment to ensuring compliance in this evolving area of finance.

Why the Increased Scrutiny?

There are several reasons why the IRS is paying closer attention to digital wallets:

Tax Gap: The IRS is concerned about the potential tax gap arising from unreported digital asset transactions ³. A recent analysis by Barclays found that investors are likely paying less than half of the taxes they owe on virtual currency trades ³. The anonymity and decentralized nature of some digital assets make it challenging to track transactions, leading to potential underreporting of income.
Transparency and Compliance: The IRS aims to promote transparency and ensure that individuals and businesses comply with tax laws in the digital economy ⁷. Just as we have a responsibility to pay taxes on our earnings from traditional sources, we also have an obligation to report and pay taxes on income generated through digital assets.
Emerging Regulations: With the rise of new technologies like decentralized finance (DeFi), the IRS is working to establish clear guidelines and regulations for digital asset transactions ⁸. The goal is to reduce inadvertent errors and noncompliance by providing taxpayers with more information through Form 1099 ⁸.

One significant development in this area is the introduction of Form 1099-DA, which brokers will use to report digital asset sales or exchanges starting in 2025 ⁷. This form will provide taxpayers with more detailed information about their transactions, helping them accurately calculate their tax liability.

Changes to Tax Basis Reporting

The IRS is ending the "universal method" for tracking the tax basis of digital assets ⁹. Previously, taxpayers could treat all their digital assets as if they were held in a single account, even if they were spread across multiple wallets or exchanges. However, starting in 2025, taxpayers will need to track the tax basis of their digital assets separately for each wallet or account. This change requires more meticulous record-keeping and may necessitate the use of specialized crypto tax software to ensure accurate reporting.

The Impact of the IIJA

The Infrastructure Investment and Jobs Act (IIJA) of 2021 has significant implications for digital asset reporting ¹. The IIJA expands the definition of a "broker" to include any person who "effectuates transfers of digital assets on behalf of another person" ¹. This broader definition means that more entities involved in digital asset transactions will have reporting requirements to the IRS. The IIJA also introduces new information reporting requirements for digital asset transactions, aiming to increase transparency and compliance in this rapidly growing sector.

Opportunities for Tax Professionals

The new regulations surrounding digital assets create opportunities for tax professionals to provide specialized advisory services ¹⁰. Many taxpayers may find the complexities of digital asset taxation daunting, and they will need guidance from knowledgeable professionals to navigate these challenges. Tax professionals can assist clients with:

Understanding the new reporting requirements.
Reconciling transaction histories.
Calculating adjusted bases.
Preparing Form 1099-DA filings.
Developing tax-efficient strategies for digital asset transactions.

By offering these services, tax professionals can help clients stay compliant with the law while also optimizing their financial strategies in the digital asset space.

IRS Audit Red Flags

While the IRS encourages voluntary compliance, it also conducts audits to ensure that taxpayers are accurately reporting their income. Certain activities related to cryptocurrency can raise red flags and increase the likelihood of an IRS audit ¹¹. These include:

Using cryptocurrency for large purchases: If you use cryptocurrency to buy a house, a car, or other high-value items, the IRS may take notice.
Suspicious activity or non-compliance: Engaging in activities that appear designed to evade taxes, such as moving large amounts of cryptocurrency between wallets or using privacy coins, can trigger an audit.

It's crucial to maintain transparency and adhere to IRS guidelines to minimize the risk of an audit.

Practical Steps for Compliance

As Christians, we are called to be honest and responsible in our financial dealings. This includes accurately reporting our income and paying our taxes. Proverbs 11:3 reminds us, "The integrity of the upright guides them, but the unfaithful are destroyed by their duplicity." Here are some practical steps to ensure compliance with IRS regulations regarding digital assets:

Be Informed: Stay updated on the latest IRS guidelines and regulations regarding digital assets. The IRS website and reputable Christian finance resources can provide valuable information.
Keep Accurate Records: Maintain detailed records of all your digital asset transactions, including purchase dates, sale prices, and any associated fees. Just as the biblical principle of accountability calls for transparency in our relationships, it also applies to our financial dealings.
Seek Professional Advice: If you have complex digital asset transactions, consider consulting with a tax professional who specializes in cryptocurrency taxation. Proverbs 15:22 says, "Plans fail for lack of counsel, but with many advisers they succeed."
Stewardship and Integrity: Remember that our finances are a gift from God, and we are called to manage them with wisdom and integrity (Matthew 25:14-30). This includes fulfilling our tax obligations as an act of obedience and responsible stewardship.

FAQs about Digital Wallets and Taxes

Q: Do I need to report every cryptocurrency transaction on my tax return?

A: Generally, any transaction where you dispose of cryptocurrency – such as selling it for cash, trading it for another cryptocurrency, or using it to buy goods or services – is a taxable event.

Q: What if I just hold cryptocurrency in a digital wallet?

A: Simply holding cryptocurrency is not a taxable event. You only realize a gain or loss when you sell, trade, or otherwise dispose of it.

Q: Are there any tax-free transactions involving cryptocurrency?

A: Yes, some transactions are generally not taxable, such as transferring cryptocurrency between your own wallets or donating cryptocurrency to a qualified charity.

Q: Where can I find more information about cryptocurrency taxes?

A: The IRS website (irs.gov) has a dedicated section on digital assets with helpful resources and FAQs. You can also consult with a tax professional specializing in cryptocurrency taxation.

Conclusion

The IRS's focus on digital wallets is a reminder that we need to be diligent in managing our finances in the digital age. By staying informed, keeping accurate records, and seeking professional advice when needed, we can ensure that we are complying with tax laws and honoring God in our financial stewardship. Let's strive to be faithful stewards of all that God has entrusted to us, including our digital assets, and manage them with wisdom, integrity, and a heart of obedience.

Works cited

Taxable transactions with digital assets - YouTube video text script - IRS, accessed February 4, 2025, https://www.irs.gov/newsroom/taxable-transactions-with-digital-assets-youtube-video-text-script
How Is Crypto Taxed? (2025) IRS Rules and How to File | Gordon Law Group, accessed February 4, 2025, https://gordonlaw.com/learn/crypto-taxes-how-to-report/
Digital assets: 2022 individual tax compliance | Baker Tilly, accessed February 4, 2025, https://www.bakertilly.com/insights/digital-assets-2022-individual-tax-compliance
Your Crypto Tax Guide - TurboTax - Intuit, accessed February 4, 2025, https://turbotax.intuit.com/tax-tips/investments-and-taxes/your-cryptocurrency-tax-guide/L4k3xiFjB
Understanding the Tax Implications of Crypto Transactions - GreenGrowth CPAs, accessed February 4, 2025, https://greengrowthcpas.com/tax-implications-of-crypto-transactions/
Taxpayers need to report crypto, other digital asset transactions on their tax return - IRS, accessed February 4, 2025, https://www.irs.gov/newsroom/taxpayers-need-to-report-crypto-other-digital-asset-transactions-on-their-tax-return
Overview of Federal Crypto Tax Reporting Requirements: business law and litigation defense services - Plunkett Cooney, accessed February 4, 2025, https://www.plunkettcooney.com/tax-law-estate-plans-probate-business-succession/crypto-tax-reporting-requirements
U.S. Department of the Treasury Releases Final Regulations Implementing Bipartisan Tax Reporting Requirements for Brokers of Digital Assets, accessed February 4, 2025, https://home.treasury.gov/news/press-releases/jy2762
Do You Own Digital Assets? Action Needed Before Year End to Favorably Allocate Tax Basis - Duane Morris, accessed February 4, 2025, https://www.duanemorris.com/alerts/action_needed_before_year_end_favorably_allocate_tax_basis_1224.html
Leveraging new IRS digital asset reporting regulations: Opportunities for personalized advisory services - Thomson Reuters tax, accessed February 4, 2025, https://tax.thomsonreuters.com/blog/leveraging-new-irs-digital-asset-reporting-regulations-opportunities-for-personalized-advisory-services/
How to Prepare for a Tax Audit Involving Cryptocurrency | CA - San Jose Tax Attorney, accessed February 4, 2025, https://www.jdteterlaw.com/business-law-blog/how-to-prepare-for-a-tax-audit-involving-cryptocurrency

Ralph V. Estep, Jr.

Christian Financial Consulting

Ralph V. Estep, Jr. is a highly accomplished professional with a diverse background in finance, accounting, technology, and entrepreneurship. As the principal at Saggio Management Group, Inc., he has demonstrated exceptional leadership and expertise in various roles throughout his career.

Ralph's educational journey began at St. Mark's High School in Newark, Delaware before attending the University of Nebraska where he was an esteemed member of the Cornhusker Marching Band and had the privilege of performing at the Florida Citrus Bowl in Orlando.

Continuing his pursuit of knowledge and excellence, Ralph earned a Bachelor of Science Degree in Accounting from the University of Delaware. He further expanded his academic achievements by obtaining a Master's in Business Administration from Wilmington University.

Throughout his professional journey, Ralph has been recognized for his outstanding accomplishments and commitment to excellence. He is a member of prestigious organizations such as the Golden Key National Honor Society and Beta Gamma Sigma International Business Honor Society.

With an extensive range of professional designations including Licensed Public Accountant (LPA), Accredited Business Accountant (ABA), Accredited Tax Advisor (ATA), Accredited Tax Preparer (ATP), and Internal Revenue Service Registered Tax Preparer (RTRP), Ralph possesses comprehensive expertise in tax preparation and financial management.

Beyond his impressive qualifications, Ralph has actively engaged with various community programs as bo… Read More

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