Do Foreign Crypto Exchanges Report to the IRS?

Many foreign exchanges have implemented Know Your Customer (KYC) protocols, which may require users to provide identification, and this is often the first step in ensuring compliance with international regulations. But does this mean they report to the IRS? Not necessarily. If the exchange is located outside the U.S. and does not have significant business within the U.S., it's less likely that they are under obligation to report directly to the IRS. However, certain international exchanges may still share information, especially if they operate within countries that have agreements with the U.S.

For instance, the Foreign Account Tax Compliance Act (FATCA) obligates foreign financial institutions to report accounts held by U.S. citizens. This could extend to some cryptocurrency exchanges that are treated as financial institutions by their local governments. Also, many exchanges are eager to comply with global regulations to avoid being blacklisted by international financial institutions. Some exchanges voluntarily comply with U.S. regulations to keep their business operations open to American users.

How IRS is Tracking Crypto Trades Globally

In recent years, the IRS has ramped up its efforts to track cryptocurrency trades, even on foreign exchanges. With the advent of blockchain analytics companies, the IRS can now trace crypto transactions more easily, regardless of the origin of the exchange. Additionally, under FATCA and the Common Reporting Standard (CRS), foreign exchanges in certain jurisdictions are obligated to report crypto holdings to the IRS if they fall under the financial institution category.

Notably, the IRS issued a clear mandate in 2019, stating that crypto is to be treated as property for tax purposes. This means that capital gains taxes apply to trades, sales, and even the exchange of one cryptocurrency for another. If foreign exchanges facilitate such transactions, they may be implicated in tax reporting. While the IRS can't directly compel exchanges outside U.S. jurisdiction to report, they can impose penalties on U.S. taxpayers who fail to declare foreign crypto assets.

The Loophole Factor and Self-Reporting Obligations

Many crypto traders used to believe that using a foreign exchange would shield them from the prying eyes of the IRS. This misconception has led to significant penalties for some traders. In fact, U.S. residents are required to report all worldwide income, including profits from foreign crypto exchanges. Failure to do so can result in hefty fines, penalties, and even criminal prosecution.

While some foreign exchanges may not directly report to the IRS, U.S. taxpayers have a legal obligation to self-report any earnings, trades, or capital gains from these platforms. The IRS has made it clear that ignorance of tax laws is not a valid excuse for non-reporting. As of 2020, the IRS Form 1040 asks directly if taxpayers have engaged in any transactions involving cryptocurrency.

A List of Some Exchanges and Their Reporting Policies

Some exchanges like Binance, which used to be based in China but now operates from Malta, claim to follow local laws. While they do require KYC, they are not obligated to report directly to the IRS. Exchanges like Kraken, however, based in the U.S., must comply with U.S. regulations, meaning they report to the IRS directly.

Penalties and IRS Enforcement

The IRS has made it clear that failing to report crypto transactions can lead to significant penalties. In some cases, fines can amount to 50% of the account balance per year, and in the most extreme cases, jail time is a possibility. It's crucial for traders, even those on foreign platforms, to keep detailed records of their crypto activities and report them on their tax returns. The IRS also uses “John Doe” summonses to request information from foreign exchanges regarding U.S. clients. In 2021, for example, the IRS sent a summons to Kraken to obtain information about users who transacted over $20,000.

In conclusion, while foreign crypto exchanges might not all report directly to the IRS, U.S. taxpayers are still required to disclose all foreign holdings and transactions. Failure to do so can result in serious financial and legal consequences.