Far from cryptocurrencies being the tax-free magic internet money many hoped for, this is no longer the case. In July, the US Internal Revenue Service (IRS) sent out letters to thousands of people who they believe have held cryptocurrencies over recent years. If you were unlucky enough to have received one of these, then you’ll know the IRS is stepping up its efforts to reap taxes on cryptocurrencies.

The letters contained different wording depending on the severity of the situation in the IRS’ view. Two are less intimidating, referring to the recipient either “not knowing” or “not having met” the requirements for tax filings related to virtual currencies. If you received one of these letters (numbered 6174 and 6174A, respectively), then you’re not beyond redemption. The letters call on the recipient to issue an amended or delinquent tax return for the relevant years.

If you received the letter numbered 6173, then your concern is understandable. The IRS already believes that you “may not have met your US tax filing and reporting requirements for transactions.” The letter instructs remedial actions and requires that you sign and return it. If you don’t, then the taxman will come knocking at your door before very long.

“Taking remedial action” essentially means correcting your previous year’s tax declarations to include your cryptocurrency positions. But this isn’t necessarily a straightforward exercise.

Crypto Taxes Are Complicated

Although Bitcoin has been around since 2009, it took the IRS a full five years to issue any ruling on the taxation of virtual currencies. Even then, the 2014 notice published by the IRS was under the premise of “preliminary guidance.” Five years since then, and it’s still the de facto word of law on crypto-taxes.

The crux of Notice 2014-21 is that the IRS doesn’t recognize Bitcoin or any other virtual currencies as currencies. Instead, they’re classified as “property” and taxed in the same way as other property such as real estate or stocks.

This has both up and downsides, depending on your position. On the one hand, it could result in lower tax liability as the upper limit for property tax can be lower than that of income. But on the other hand, if you lost out during the crypto winter of 2018, the tax losses you can write off for property purposes are limited. You could potentially take a substantial tax hit.

But it gets even more complicated. Property isn’t generally used as a medium of exchange but the IRS has regulations that govern property transactions. In theory, this means that you could be on the hook for capital gains taxes on purchases even as trifling as a morning cup of coffee if you bought it with crypto.

Consider how the entire cryptocurrency and blockchain ecosystem has evolved, and the complexities that the IRS tax approach creates for anyone involved in the space. Day traders can be working with multiple different token pairs. Employees and contractors of blockchain startups are being paid in tokens. Airdrops and forks. Even the most money-minded crypto enthusiast can see how it starts to become overwhelming.

A Long Time Coming

So, if the IRS issued this notice in 2014, then why has it taken so long for them to start enforcing tax on cryptocurrencies? After all, we know that Bitcoin isn’t anonymous.

Well, we can assume that the IRS has neither the resources or the know-how to start examining blockchain transactions. But as it happens, they didn’t need to. Once again, centralized exchanges have proven to be the Achilles heel of crypto and this time, not because of hackers.

In 2018, the IRS obtained a court order compelling Coinbase to hand over data about users and cryptocurrency transactions. We can safely expect that other exchanges will be ordered to do the same.

So, the July letters issued by the IRS are the culmination of many years of intent to tax cryptocurrencies. How can the average, law-abiding crypto user avoid falling foul of the Fed?

Not Just Your Accountant's Problem

If you use an accountant, then perhaps you’re hoping they can take care of all this for you. Maybe they can, but chances are the average accounting firm isn’t necessarily up to speed with cryptocurrency tax laws. After all, understanding crypto can be a rabbit hole all by itself.

Some of the bigger accounting firms may by now have onboarded specialists in cryptocurrency, they might be a good option, but they will most probably be more expensive. Such services are also likely be in high demand, more so now that the IRS is taking enforcement action.

In the case of crypto taxation, blockchain might also be the best solution to manage it. An easier and more cost-effective proposition may be to engage the services of Bittax, a blockchain platform which traces cryptocurrency transactions, including the dates and US dollar value at the time. The service provides you with a complete and accurate report which complies with IRS requirements. It doesn’t matter how many different exchanges or wallets you’ve used - the software takes care of all of it.

Bittax can also be used to forward-plan your taxes that will become due on cryptocurrency transactions. The algorithm will calculate your taxes in real-time as transactions are taking place. This means you can put the funds aside without taking the entire hit at the end of the fiscal year.

It seems somewhat ironic that the US government has decided to enforce tax laws on the monetary gains of a technology that they don’t yet know how to regulate. Even now that Facebook’s Libra plan has forced lawmakers to put their foot on the gas, there seem to be no firm decisions in sight.

Nevertheless, to paraphrase Ben Franklin, death and taxes are the two certainties we face in this life. US crypto users need to figure out how to correctly include digital asset positions in their tax returns if they want to stay on the right side of the law.

Jim Hoffer is founder and managing director at Hoffer Financial Consulting. Follow him on Twitter.