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With Tax Day in the US on April 18 and the new tax year just starting on April 5 in the UK, cryptocurrencies are top of mind for tax watchdogs such as the Internal Revenue Service (IRS), HM Revenue and Customs (HMRC) – as well as other tax administrations around the world.
Taxpayers in many jurisdictions are now expected to report capital gains from their cryptocurrency sales, and other activities such as investing and trading involving non-fungible tokens (NFTs) are also increasingly facing tax scrutiny. Anticipated measures in the US will require crypto exchanges and other companies to report information about their customers for tax purposes, while the EU also plans to extend tax reporting requirements to cryptoasset service providers.
As cryptocurrency regulations tighten, tax authorities are turning their attention to identifying individuals and businesses that violate tax laws — including confiscating their crypto assets. As criminals engage in increasingly complex money laundering typologies to hide their crypto activity, block analysis solutions can help uncover transactional activity associated with tax crimes.
Tax crimes and cryptocurrencies
Tax crimes involving cryptocurrencies and related money laundering activities can take many forms, and according to the IRS, they are growing rapidly. Social media posts even include instructions and guides on how to avoid taxes using cryptocurrencies, making the need to crack down on these crimes all the more important.
While tax-related offenses are still not predicate money laundering offenses in all jurisdictions, tax crimes and money laundering activities are often closely related – and this is often true in the cryptocurrency world. Detecting tax crimes in cryptocurrencies can often help detect money laundering activities associated with other underlying criminal activities, such as fraud, and vice versa.
For example, in November 2020, a former Microsoft contractor was sentenced to nine years in prison for fraud. According to the criminal complaint against him, Volodymyr Kvashuk was hired by Microsoft to test a new online store that allowed payment with digital gift cards. During the testing phase, Kvashuk made unauthorized payments through Microsoft systems and stole and sold $10 million worth of gift cards.
Kvashuk then sold gift cards for Bitcoin – including the Paxful peer-to-peer exchange service, which is now shutting down – and then eventually traded the Bitcoin back into dollars on a major US stock exchange.
A law enforcement investigation into his blockchain activity found that he moved some Bitcoin through ChipMixer, a mixing service recently dismantled by US and European law enforcement agencies, to disguise its origin before depositing the funds on a US exchange. Kvashuk used the proceeds from the sale of bitcoins on the US stock exchange to buy luxury items, such as cars and a $1.6 million house.
After undertaking this activity, Kvashuk attempted to falsify his tax records. When filing his tax return with the IRS, Kvashuk stated that he received the bitcoin as a gift, with the goal of exempting $1.6 million in bitcoin income from income tax.
NFTs have also recently appeared in tax-related cases. In February 2022, UK HMRC seized NFTs that were purchased with the proceeds of a Value Added Tax (VAT) scam.
In March 2023, Israeli authorities identified individuals they accused of selling more than 1,000 Western Wall NFTs to generate more than $2 million in ether revenue. Israel’s tax authority alleges that individuals funneled ether income through numerous intermediary wallets, suggesting possible efforts to distance themselves from the undeclared source of their wealth.
Key red flags
These and other cases show the use of crypto-assets in tax crimes and related money laundering activities. Some red flag indicators that may be associated with these crimes include:
- Users of an exchange that sends or receives crypto to offshore crypto exchanges with weak KYC standards and/or exploits exchanges based in high-risk jurisdictions and regions associated with tax evasion.
- An individual using offshore exchanges may also engage in activities designed to obfuscate the flows of their crypto assets, such as reliance on mixers.
- Exchange clients can fund their accounts with fiat currencies originating from offshore bank accounts or brokerage houses.
- Ultra High Net Worth Individuals (UHNWI) can open accounts and try to trade a large number of cryptoassets on the exchange. When asked about the source of funds, they may refuse to provide information or may provide inconsistent and unconvincing information.
- Crypto exchange users – including UHNWIs – can claim to have a crypto asset as a result of a life event such as a divorce settlement, gift or inheritance, but cannot provide documentary evidence of the event in question. Some individuals also try to shift fiat assets into cryptocurrencies as a method to conceal assets during divorce or similar proceedings.
- US citizens may try to open accounts on foreign exchanges in order to avoid US tax filing requirements. They may not be willing to answer questions about their activity.
- Corporate entities may have accounts on exchanges that show a level of cryptoasset trading that is inconsistent with their stated business activities. They may try to declare their crypto assets as technology expenses – instead of properly declaring any capital gains.
- Individuals or businesses that receive income or payment for goods and services in cryptoassets – or that generate significant income from activities such as mining – seek to avoid reporting cryptoasset income for tax purposes.
- Individuals can buy and sell high-value NFTs and can send the proceeds through services such as mixers or high-risk exchanges to avoid reporting the proceeds of those sales.
After proceeds of crime tax on cryptocurrencies
The activities described above have a clear objective: to disguise the nature of one’s activity by deliberately engaging in transactions and conduct designed to obscure its purpose.
However, when tax criminals transfer funds using cryptoassets, their transactions can be detected on the blockchain – intelligence that can help expose the illegal nature of their underlying activity.
For example, when individuals use mixers to try to hide their cryptoasset transactions, blockchain analytics can identify where those individuals are sending funds to – or receiving funds from – the mixers. IRS agents learned in part that he was sending funds from the ChipMixer service to a US exchange and discovered that Volodymyr Kvashuk was trying to hide details about the origin of his Bitcoin income, which he lied about when filing income taxes.
Similarly, blockchain analytics can help determine whether exchange users in jurisdictions such as the US, UK or EU are sending funds or receiving transfers from exchange services in tax haven jurisdictions – another potential red flag.
Finally, in cases such as those described above involving NFTs, multi-asset blockchain analysis solutions such as Elliptic’s Investigator software can shed light on the flow of funds in assets such as Ether, which illicit actors may attempt to conceal by transferring funds through a mixer or through multiple intermediary wallets before depositing them on the exchange.
In another case in October 2021, the US Department of Justice (DoJ) announced that two individuals had pleaded guilty to tax evasion related to their initial coin offering (ICO) profits. According to the DoJ, two individuals, who launched an ICO called Bitqyck, received fiat currency investments from buyers of Bitqyck tokens and then used those proceeds to purchase crypto assets, which they then used to purchase items such as art and vehicles. The couple deliberately omitted proceeds from the sale of cryptoassets from their personal and corporate tax returns.
In another case identified by the Internal Revenue Service (IRS), US citizens repatriated funds from offshore foreign brokerage accounts that they did not report for tax purposes, transferred the funds to a US bank account, and then purchased cryptoassets on a US cryptoasset exchange. with those same means. The tax evaders then used the digital assets they purchased to purchase goods and services without reporting any gains or losses made in the crypto-asset trade.
The above image from Elliptic Investigator shows the flow of ether between an NFT related scam and a crypto exchange. Tax crimes can be associated with NFTs where NFT creators try to hide the income they generate.
As we celebrate Tax Day in the US, it’s important to be alerted to cryptocurrency-related tax crimes and related blockchain fund flows.
Those who engage in tax crimes may try to hide their activity, but blockchain analytics can shed light on the associated flows of funds. Contact us to learn more about how Elliptic’s blockchain analytics solutions can enable you to identify illicit activity in cryptoassets.
