Taxpayers who transact business in cryptocurrency must report their virtual earnings to the IRS and pay federal taxes on that income.  While buying digital currency won't prompt a tax bill, converting it to cash, trading for another coin or using it for purchases may trigger levies.  Non-payment of federal income tax on cryptocurrency earnings can result in prosecution for tax evasion or tax fraud and up to five years in federal prison, and the IRS has made investigations into this type of crime a high priority.

In 2021, Congress passed the $1.2 trillion bipartisan infrastructure law, with a provision requiring annual tax reporting from digital currency brokers starting in 2023.  The infrastructure bill will require crypto exchanges to send Form 1099-B, a federal tax document used by traditional brokerages, to report an asset's yearly profit or loss.  One copy goes to the IRS, and investors receive the second one to report the activity on their tax return, making it harder for dodgers to bypass the IRS.  An estimate from the congressional Joint Committee on Taxation expects the measure to bring in nearly $28 billion over a decade.

Since 2019, there's been a question about “virtual currency” on the front page of the 1040 tax return, asking filers to disclose their taxable crypto activity. The question reads: “At any time during [the past year], did you receive, sell, exchange or otherwise dispose of any virtual currency?”   You may respond no if you bought and held cryptocurrency with U.S. dollars or transferred digital assets between your wallets.  However, you'll need to say yes if you sold crypto, exchanged one virtual currency for another, used it for purchases, received it as payment, acquired it through mining or staking and more.

If you check yes, you're flagging yourself, and the IRS is going to be looking for some sort of capital gain or loss on your Schedule D.  A mismatch may trigger a manual IRS review.  But if you don't report taxable crypto activity and face an IRS audit, you may incur interest, penalties or even criminal charges for tax evasion or fraud

Just last week in the Southern District of Florida, a South Florida resident pled guilty to attempted tax evasion related to the nonpayment of federal income tax on cryptocurrency earnings.  During a hearing in Ft. Lauderdale, the defendant admitted that he used sophisticated on-line techniques to conceal from the IRS over $1 million in cryptocurrency he earned through illegal dark web transactions. For example, he ran his virtual currency transactions through “mixers,” on-line services that pool together (mix) the cryptocurrency transactions of different users, then distribute “clean” cryptocurrency to the users' virtual wallets, making it harder to determine the identity of those dealing in the cryptocurrency.  The defendant is scheduled to be sentenced in December.