IRS problems aren't as complicated as they look once you see the structure. I'm attorney Darrin Mish. I've represented taxpayers before the IRS for three decades — in Florida, Colorado, Texas, and internationally. Here's the plain-English breakdown.
The Question That Has a Surprising Answer
A U.S. person buys Bitcoin on a foreign exchange. The Bitcoin sits there. The price goes up. The U.S. person never converts it back to dollars. They never sell it. They never move it. The question they often ask: as long as I do not bring it back, do I owe U.S. tax?
The answer is that holding alone does not trigger U.S. tax. But the events that typically happen with crypto – even on foreign exchanges – almost always do. The myth that offshore crypto is somehow exempt from U.S. taxation is one of the most expensive misconceptions in the space.
U.S. Tax on Worldwide Income
The U.S. taxes citizens and residents on worldwide income. The location of the exchange does not change this. A U.S. person who realizes gain on a Binance trade owes U.S. tax on that gain just as if the trade had happened on Coinbase.
This is foundational. The geographic location of the trading platform is irrelevant to U.S. tax liability for U.S. persons. The only thing that matters is whether a taxable event occurred and whether there was a gain or loss.
What Counts as a Taxable Event
The IRS treats crypto as property under Notice 2014-21. Every disposition of property is potentially a taxable event. For crypto, the most common taxable events:
Selling crypto for fiat (USD, EUR, etc.). The gain or loss is the difference between sales proceeds and adjusted basis.
Swapping one crypto for another (BTC for ETH, ETH for SOL, etc.). Each swap is a deemed sale of the disposed crypto at fair market value, with a gain or loss recognized.
Converting crypto to stablecoins (BTC for USDT, ETH for USDC, etc.). Even though USDT and USDC are pegged to USD, the conversion is a disposition.
Using crypto to pay for goods or services. The crypto is treated as sold at fair market value at the time of payment, with gain or loss recognized.
Receiving crypto as payment for services, mining, staking, or other income. The fair market value of the crypto at receipt is ordinary income.
Earning yield through DeFi staking, lending, liquidity provision, or similar activities. Most of these generate ordinary income at the time the yield is earned.
What Does Not Trigger Tax
Several common crypto activities do not by themselves trigger U.S. tax:
Buying crypto with fiat. No gain or loss is recognized; basis is established at the purchase price.
Holding crypto. Appreciation is not taxable until a realization event occurs.
Transferring crypto between your own wallets or accounts. Moving Bitcoin from a foreign exchange to a self-custody wallet, or from one exchange to another, is generally not a taxable event – the crypto remains owned by the same person.
Gifting crypto (subject to gift tax rules, separate from income tax). Gifts under the annual exclusion are not reportable for gift tax.
Inheriting crypto. Inheritance is not taxable income to the recipient; the recipient takes a stepped-up basis to fair market value at the decedent’s death.
The “I Did Not Cash Out” Myth
One of the most common misunderstandings is that no tax is owed until crypto is converted back to fiat and brought to a U.S. bank account.
This is wrong. The taxable event is the disposition – the trade, the swap, the conversion – not the eventual movement to a U.S. bank account. A taxpayer who swapped Bitcoin for Ethereum on Binance triggered a taxable event regardless of whether they ever convert anything back to USD.
For active traders, this means hundreds or thousands of taxable transactions per year. Each one needs to be calculated, reported on Form 8949, and the gain or loss flowed through to the return.
The Information Reporting Layer
The IRS gets information about U.S. taxpayers’ foreign crypto activity through multiple channels:
John Doe summonses. The IRS has obtained court-authorized summonses against multiple exchanges, including foreign exchanges, requiring production of U.S. account holder records.
FATCA-style information exchange. While crypto-specific information exchange is still developing, the general FATCA framework increasingly captures crypto exchange accounts.
Bank reporting. Withdrawals from foreign exchanges to U.S. bank accounts generate domestic bank reports that the IRS can match against income.
Whistleblower programs. The IRS pays rewards for information about tax noncompliance.
Voluntary disclosure data. Past disclosure program participants provide data points the IRS uses to triangulate other taxpayers.
The position that foreign crypto activity is invisible to the IRS is no longer accurate. The information channels are real, and the matching is increasingly automated.
Capital Gains Rate Treatment
Crypto held more than one year before disposition gets long-term capital gains rate treatment: 0 percent, 15 percent, or 20 percent depending on income level.
Crypto held one year or less gets short-term capital gains treatment, which is the same as ordinary income rates (10 percent to 37 percent depending on bracket).
The holding period starts the day after acquisition. For taxpayers with multiple acquisitions, the IRS default rule is first-in-first-out (FIFO) for identifying which units are sold. Specific identification is allowed if the taxpayer can show which units are being disposed of.
The choice between FIFO and specific identification can substantially affect tax liability for active traders. Specific identification often produces better results by allowing the taxpayer to selectively realize losses or short-term gains in lower-income years.
The Net Investment Income Tax
Crypto investment gains may be subject to the 3.8 percent net investment income tax under IRC Section 1411. The NIIT applies to investment income above modified adjusted gross income thresholds: $200,000 for single filers, $250,000 for married filing jointly.
For high-income crypto investors, the NIIT effectively raises the federal capital gains rate from 20 percent to 23.8 percent on amounts above the threshold.
The NIIT generally does not apply to nonresident aliens, but applies to U.S. citizens and residents regardless of where the crypto is held.
State Tax
State income tax follows the federal characterization in most states. Crypto gains are state taxable income at the resident state’s rate.
California (up to 13.3 percent), New York (up to 10.9 percent), Hawaii (11 percent), and other high-tax states impose substantial state tax on crypto gains. Florida, Texas, Tennessee, Nevada, and other no-income-tax states have no state-level tax.
The state where the taxpayer is a resident, not the location of the exchange, determines state tax obligations.
Specific Wrong Answers
A few specific positions I have seen taxpayers take that produce wrong results:
“My crypto is on a non-KYC exchange, so the IRS does not know.” The IRS does not need exchange-level information to assess tax. Information from any source – banking, wallet analytics, social media, whistleblower – can support an assessment.
“I have a foreign address on the exchange.” Address registration does not change tax residency. A U.S. person remains a U.S. person for tax purposes regardless of what address is on file with an exchange.
“I am in a country with no crypto tax.” Foreign tax treatment does not affect U.S. tax. A U.S. citizen in Dubai still owes U.S. tax on crypto gains even though Dubai has no income tax.
“I have not converted to fiat, so no tax.” Crypto-to-crypto swaps are taxable events. Holding without disposing avoids tax; trading without converting to fiat does not.
Three Steps for Compliance
First, identify every taxable event. Sales, swaps, conversions, payments, mining rewards, staking rewards, DeFi income.
Second, calculate the gain or loss on each. Basis tracking is essential. Crypto tax software ingests most exchange data and produces the calculation.
Third, report the gains, losses, and ordinary income correctly on Form 8949, Schedule D, Schedule 1, and the main Form 1040.
Get the Tax Reported Correctly
After 32 years of working tax cases and several years focused on the crypto compliance challenge, I will tell you the cleanest outcomes come from accurate reporting in the current year and prompt cleanup of any prior years where the reporting was incomplete. Contact the Law Offices of Darrin T. Mish, P.A. at (813) 229-7100. We address current-year reporting and use disclosure programs to clean up prior years where needed.