In recent years, the rapid growth of cryptocurrencies has introduced new challenges for tax authorities and taxpayers alike. As digital currencies like Bitcoin and Ethereum become more prevalent, many individuals have found themselves unsure about the tax implications of their crypto transactions.
Compounding this confusion is the potential risk of being flagged for tax evasion if income from cryptocurrency holdings or trading activities needs to be appropriately reported. In Israel, as in many other countries, the tax authorities are becoming more vigilant in uncovering unreported income, primarily from decentralized and largely unregulated sources like crypto.
Voluntary disclosure is one of the most effective tools for individuals looking to rectify past mistakes. This legal process allows taxpayers to come forward and report previously undeclared income, including from cryptocurrency activities, without facing criminal charges.
However, given the complexity of crypto taxation, it is crucial to navigate this process with the assistance of a legal professional. Doron Levy, a senior partner and head of the Tax and Class Action practices at Amit, Pollak, Matalon & Co, explains why involving a lawyer in voluntary disclosure is essential, especially when dealing with the murky waters of cryptocurrency taxation.
Doron, can you explain voluntary disclosure and why it has become particularly relevant in recent years?
“Voluntary disclosure is a legal process allowing individuals or businesses to disclose previously undeclared income or assets to the tax authorities without criminal prosecution. This is especially relevant today because of global efforts to increase tax transparency and digitalize financial transactions. The Israeli Tax Authority (ITA) and tax authorities worldwide are focusing more on uncovering hidden income and assets, especially those involving offshore accounts and cryptocurrencies. With the rise of cryptocurrencies, which are notoriously difficult to trace, more individuals must report income they may have previously overlooked or intentionally concealed”.
Adv. Levy added: “The voluntary disclosure process allows individuals to come clean, pay their due taxes, and avoid potential criminal prosecution. However, it’s a highly complex process, where a lawyer becomes indispensable”.
You mentioned cryptocurrencies. Why is this area particularly complex for taxpayers, and how does it intersect with voluntary disclosure?
“Cryptocurrencies, such as Bitcoin or Ethereum, present a unique challenge because of their decentralized nature and the fact that they operate outside traditional banking systems. Many people misunderstand how they should be taxed. Buying, selling, or even exchanging one cryptocurrency for another can generate a taxable event, but the valuation of these transactions is tricky. This is where expertise comes in. You need to calculate the profit or loss from these transactions in terms of both the timing and the rates applicable at the time of each transaction”.
“Cryptocurrencies are usually traded in dollars, so a person needs to know how to convert that to shekels based on the exchange rate at the time of the transaction. Plus, crypto prices can be highly volatile, complicating things even further. In voluntary disclosure, a taxpayer might have years of crypto transactions that need to be examined, sometimes retroactively, to determine how much tax is owed. It’s not straightforward and requires a deep understanding of the technology and the tax laws”.
This process is highly technical. Why is it essential to involve a lawyer and not rely on an accountant or tax preparer?
“While accountants play a critical role in handling financial records and calculating taxes, voluntary disclosure, especially involving cryptocurrencies, requires legal expertise. First and foremost, a lawyer provides confidentiality. When you approach the tax authorities with a voluntary disclosure, you do so on the condition of anonymity. Your lawyer acts as a buffer between you and the authorities, allowing for protection during negotiations because all the information you give your lawyer is privileged and confidential by law”.
“More importantly, determining the tax owed isn’t black and white. It involves interpreting the law about your specific case, especially when crypto is involved and this interpterion can be very creative. For instance, there is room for argument over how profits should be calculated, what rates should apply, and what exchange rates to use. A lawyer with experience in tax and crypto can negotiate with the tax authorities to ensure you pay the minimum possible amount legally required”.
What happens if someone does not go through voluntary disclosure but is later caught evading taxes on their cryptocurrency profits?
“The consequences can be severe. The tax authorities can initiate civil and criminal proceedings if they discover unreported income or assets. In the case of cryptocurrency, because it’s a relatively new area and many people are unfamiliar with the tax implications, the authorities may be lenient if the evasion appears accidental. But if they believe there was an intentional effort to hide income, they won’t hesitate to impose significant penalties, including hefty fines, interest on unpaid taxes, and even imprisonment”.
“Voluntary disclosure offers a way to avoid these harsh consequences. It’s an opportunity to come clean and correct past mistakes without risking criminal charges. Of course, the person will still need to pay taxes on the unreported income, but it’s a much better outcome than facing legal action”.
Could you give an example of how a voluntary disclosure process involving cryptocurrencies might work?
“Sure. Someone started trading cryptocurrencies a few years ago and made significant gains but didn’t report those profits to the tax authorities. They realize now that they could face penalties if caught, so they decide to go through the voluntary disclosure process. The first step would be for the individual to consult with a tax lawyer like myself. We would review all their crypto transactions—every buy, sell, and trade over the years. Then, we’d calculate the total taxable income from those transactions, remembering that the rates and profits must be converted from the currency in which the transactions were made (typically USD) to shekels”.
“Next, we’d anonymously submit the information to the tax authorities, allowing the taxpayer to stay protected until an agreement is reached. During this time, we’d negotiate with the authorities to reduce the tax liability as much as possible, taking into account potential deductions, the timing of the transactions, and any applicable exchange rates. Once an agreement is reached, the taxpayer can come forward, pay the owed taxes, and finalize the process”.
How does Israel’s tax authority treat cryptocurrency transactions? Are there specific rules for crypto?
“Israel has established clear rules for taxing cryptocurrency transactions. The ITA treats cryptocurrency as a financial asset, not a currency. That means any gains from selling, exchanging, or using crypto are subject to capital gains tax, just like profits from stocks or bonds. The tax rate can vary depending on the individual’s tax bracket, but generally, it’s around 25%”.
“However, suppose someone is trading cryptocurrencies as a business or doing so on a large scale. In that case, the income may be taxed as ordinary business income, which could result in higher tax rates. This distinction—whether the crypto transactions are considered personal investments or business activities—is crucial because it can drastically affect the tax owed. It’s another reason why a tax lawyer is essential in helping individuals navigate this complicated area”.
What advice would you give someone who still needs to report their cryptocurrency holdings or profits to the tax authorities?
“My advice is simple. Don’t wait. Cryptocurrency may seem like an unregulated frontier, but tax authorities are catching up fast. The ITA has already taken steps to identify unreported crypto income, and international efforts are ongoing to increase tax transparency across borders”, concludes tax lawyer Doron Levy.
If you haven’t reported your crypto profits, taking the initiative now is better than waiting for the tax authorities to knock. Voluntary disclosure allows you to correct past mistakes and settle your tax obligations on your terms, with less risk. And most importantly, work with a professional who understands crypto’s legal and financial aspects. It’s a complex area; proper guidance can make all the difference.
