As U.S. regulators continue tightening oversight of digital assets, cryptocurrency tax reporting is facing deeper scrutiny from the Internal Revenue Service. Clinton Donnelly, a U.S. Treasury-licensed Enrolled Agent and founder of Donnelly Tax Law, said in a recent interview that limited formal guidance on crypto taxation has not slowed the IRS’s audit activity. Instead, investors are being pushed into a compliance environment where disclosure, documentation, and consistency across years matter more than ever.
One of the most important developments, according to Donnelly, was the addition of the cryptocurrency question to the 2019 U.S. tax return. The yes-or-no format requires taxpayers to explicitly state whether they were involved with crypto, making the answer part of a signed filing submitted under penalty of perjury. In Donnelly’s view, this changed the tone of crypto tax reporting by forcing taxpayers to take a clear position rather than remain vague or silent.
That seemingly simple question may also have broader implications. If a taxpayer reports crypto gains in one year, it can implicitly suggest that the assets may have been acquired in earlier years. That, in turn, can raise questions about whether prior returns were complete and accurate. Donnelly argues that this dynamic may increase the odds of older filings attracting attention from the IRS.
Audits Focus on Asset Flows, Not Just Gain Calculations
Donnelly said his firm had seen two cryptocurrency-related audit cases among clients, and one of them involved a taxpayer who claimed never to have received the IRS warning letters that were sent to many U.S. crypto holders. Even so, the taxpayer was still audited. The example suggests that a prior warning letter may not be the only path to examination.
According to Donnelly, the IRS appears less concerned with minor differences in how taxpayers calculate capital gains using different software or reporting tools, and more concerned with whether the full picture of inputs and outputs can be reconciled. In other words, the agency wants to see that all money going in and all assets or cash coming out are accounted for. This is especially important where fiat movements are involved.
He described one audit example involving a 2017 return with just under $40,000 in crypto gains. The amount was notable not because it was exceptionally large, but because it shows that an audit does not necessarily require massive profits to be triggered. A return can attract scrutiny if the broader asset trail, transaction record, or disclosure pattern raises questions.
For active traders, another complication is exchange reporting. Donnelly noted that some high-frequency traders become alarmed when they see large gross proceeds reported on 1099-K forms from exchanges. Those forms may reflect trading volume without incorporating acquisition costs. That can make the numbers look inflated and create hesitation around filing. Still, Donnelly’s view is that full reporting of proceeds is generally safer than omission, particularly if the taxpayer can later substantiate basis and reconcile the final gain or loss.
AML Framing Is Becoming Central
One of Donnelly’s key observations is that the IRS’s questions often seem to fit within an anti-money laundering framework rather than a purely tax-accounting one. He suggested that many crypto market participants feel the government views digital asset traders as potentially connected to unlawful activity, even if the vast majority are not. He referenced a Chainalysis finding cited in the interview that the darknet represented less than 1% of total crypto usage, underscoring that illicit activity remains a small share of the market overall.
Even so, Donnelly believes the anti-money laundering narrative gives regulators and enforcement agencies a politically safer route to increase scrutiny. Rather than framing enforcement as a broad crackdown on ordinary crypto traders, authorities can present investigations as efforts to target money laundering risks, suspicious fund flows, or account concealment. That distinction matters because it shapes both the tone of enforcement and the types of questions asked during an audit.
In practical terms, this means taxpayers may be asked to explain not just taxable gains, but also where assets came from, how they moved between wallets and exchanges, whether cash was involved, and whether any foreign-held accounts should have been disclosed. For many taxpayers, these are recordkeeping challenges as much as tax challenges.
Foreign Exchanges and FBAR Exposure
Donnelly also highlighted what he sees as a major risk area: FBAR compliance. The Report of Foreign Bank and Financial Accounts applies when a U.S. taxpayer’s foreign financial accounts exceed an aggregate value of $10,000 at any point during the calendar year. While FBAR is administered by the IRS, it is tied to the Bank Secrecy Act rather than the tax code itself, which gives it a different enforcement posture.
That distinction is significant. Donnelly argued that FBAR can be especially powerful in enforcement because it is connected to anti-money laundering policy and can bring the Financial Crimes Enforcement Network into the picture. For crypto users who have traded through overseas exchanges, this creates potential exposure beyond ordinary income or capital gains reporting.
He warned that penalties can be severe. In the interview, he described FBAR penalties as starting at $10,000 and potentially increasing based on the number of unreported foreign accounts. If multiple offshore platforms were used and filings were missed over several years, the cumulative liability could become very large. In his telling, a taxpayer who reveals multiple foreign exchange accounts during a later disclosure process may unintentionally expose themselves to stacked penalties across several tax years.
Whether or not every crypto exchange account ultimately falls within FBAR rules is a matter taxpayers should evaluate carefully with qualified professionals, but Donnelly’s broader point is clear: the intersection of crypto, offshore platforms, and anti-money laundering enforcement can create a far more serious compliance issue than many users assume.
Why Recordkeeping Matters More Than Ever
The interview also reinforces a broader lesson for digital asset investors: crypto tax compliance is no longer just about estimating gains at year-end. It is increasingly about building a complete, defensible record of all activity. That includes wallet transfers, exchange trades, fiat deposits and withdrawals, prior-year holdings, and the use of any foreign platforms.
Donnelly said his mission is to help clients file what he calls a “bulletproof” return. The phrase reflects the reality that even innocent omissions can lead to outsized consequences if a return later becomes the subject of review. In the crypto sector, that challenge is amplified by fragmented records, inconsistent exchange reporting, and the technical complexity of tracking asset movements over time.
For taxpayers, the practical takeaway is straightforward. They should maintain comprehensive transaction histories, review whether past returns align with current disclosures, and assess whether any foreign account reporting obligations may apply. As the IRS continues refining its approach to digital assets, complete documentation and careful filing may be the strongest defense against both tax disputes and broader regulatory scrutiny.
More broadly, the article highlights how crypto taxation in the United States is evolving from a narrow question of profit calculation into a wider compliance issue involving traceability, disclosure, and AML-sensitive reporting. For market participants, that shift may prove just as important as any future change in tax rates or formal guidance.