What is Monero?

Monero is a cryptocurrency founded in 2014 focusing on the goals of anonymity and privacy. Monero uses the decentralized technology of the blockchain with more complex layers of security. The main difference is moving away from a public ledger or transactions that can be read and accessed by anyone towards a hidden network where the movement of funds is untraceable.

Technically, Monero could be even more complex than Bitcoin or Ethereum. Using the same underlying blockchain concepts but adding multiple layers of security to avoid the record of transactions requires complex software ideas to ensure it isn’t cracked. If you want a more in-depth guide on how Monero works from a technical perspective check out Blockgeek’s guide.

While there are many interesting areas of Monero, this article will try to dive into the possible tax implications and consequences of using it. The driving use case behind Monero is hiding transactions from someone looking, but what if this doesn’t hold forever? What if someone cracks the code eventually? Are you willing to risk legal repercussions to hide whatever you are doing?

How the government currently tracks Crypto

The US government has been public about the fact they are tracking crypto since 2013/14. The primary way in which they do this has not changed. They require exchanges to report user details and transaction records. They want to locate the point where someone first buys crypto and then trace the movement of funds from their across addresses and between coins. They also expect individual users to report their transactions and have made it a legal requirement to do so. For the majority of users, the government wouldn’t know exactly how much tax they owe but they would likely know if you have traded crypto at all and could make an educated guess as to roughly how much you could owe.

Making it a legal requirement to report your own crypto transactions opens up the possibility of an audit if you fail to comply. An audit would likely shed light on all your crypto assets and transactions. Some might think the chance of an audit is slim to none but there are a few factors to consider the next time you file your taxes:

• The government needs tax revenue now more than ever

• With the rising interest and prices in the crypto space is a goldmine for tax revenue

• Are you willing to risk back taxes, fines, and possible jail time if you are caught?

Given anyone can track the movement of crypto if they know the source address, Monero presents an interesting solution - once the funds are on the platform they can’t be traced.

Why people think Monero is safe

Monero has the ability to hide all transaction records on the platform, which makes it perfect in theory if you want to hide illegal activity. In 2020, the platform is still secure with complete privacy. There are endless possibilities for how and why this could be useful for avoiding government scrutiny and taxes. This step of the process could be viewed as safe to avoid taxes on crypto gains but it’s easy to see after a bit of digging the potential flaws in this plan.

Why it is not safe

There are several reasons why using Monero wouldn’t work to avoid or minimize taxes which can be broken into three categories - buying crypto, withdrawing your profits, and the vulnerabilities of Monero.

First, if we assume Monero is in fact completely safe (we’ll get to why this isn’t a good idea soon) there are still two points in the process where the government could catch you.

When you buy a cryptocurrency for fiat currency (such as USD or GBP) as mentioned above, the government can see this and even if they didn’t there is always a chance they will. Until your funds are on Monero the transactions can and will be traced back to you. The unfortunate reality of crypto is that it isn’t mainstream yet so using profits from crypto needs to be transferred back to fiat currency. This provides another step in the process where the tax office could see the transaction, going through an exchange to convert the money back to a currency you can use day to day would be seen by anyone looking for it.

The most deceptive problem with Monero is that it is secure for now. The question users have to ask themselves is are they sure Monero will always remain safe? Think about the number of hacks and exploits that occur weekly in the crypto world, it is definitely possible the government could crack a cryptocurrency themselves given they have the motive.

In fact, in 2019 there were three known vulnerabilities that could potentially be used to identify real transactions and trace the flow of funds. On top of that, in September 2020 the IRS launched a challenge offering a $625,000 bounty if someone can find a way to deanonymize transactions on the Monero network. They have both a clear motive and a plan for how to achieve this so realistically it is only a matter of time before they are successful.

When you think about it hackers have a financial incentive to steal crypto the IRS and other tax agencies also have a financial incentive to crack Monero. If they can trace transactions they can go after more tax revenue and also fine users who have failed to declare taxes. It would be possible for them to argue that using Monero would not just be tax avoidance but tax evasion which is a serious crime.

What you should be doing?

It all boils down to risk vs reward. The risks have been laid out extensively in this article and include a criminal offense, the rewards are more personal, and for you to decide, how much could you save by using Monero. Given the probability that in the end your funds will be traced it would make sense never to take the risk.

Declaring your Monero transactions along with the rest of your crypto trades is the best choice, this involves keeping a record of all your transactions in dollar terms and presenting your yearly capital gains or losses as part of your tax report. While the crypto tax laws are changing fast these will always remain staple requirements of any tax office.