How Tax Authorities Detect Undeclared Cryptocurrency Income

A self-custody wallet contains 200,000 USDT. The person lives in the European Union, trades through DeFi, occasionally uses a centralized exchange and pays everyday expenses with a crypto card. Their tax declaration shows only regular salary income. They are confident that the wallet, the keys to which are controlled only by them, is not connected to their name, that a decentralized exchange does not request a passport, and that the card simply charges cryptocurrency. Therefore, they believe they cannot be identified.

This confidence usually disappears when a bank asks to confirm the origin of funds, when a person purchases real estate, or when tax authorities begin comparing declarations with actual financial activity. Such an audit does not require access to a seed phrase. It is enough to have points where a person’s identity intersects with a wallet, a card, a bank account or a significant purchase.

Tax authorities do not need full access to the wallet

It is not necessary to go to the other extreme and assume that tax authorities receive a personalized real-time feed of every transaction from a self-custody wallet. Such a universal surveillance system does not exist. However, the system has an increasing number of separate data sources that can be matched against each other.

A centralized exchange or another regulated crypto service provider knows the client’s identity after KYC verification. European rules on the transfer of information in crypto transactions require operations to be accompanied by information about the sender and recipient, and when transfers are made to a self-custody address, the provider applies a risk-based verification of wallet control. The blockchain itself publicly stores the movement of funds. The bank sees incoming fiat transactions. The crypto card issuer knows the client and records transactions related to conversion and payments.

From January 1, 2026, DAC8 expanded annual tax information exchange to reportable crypto-asset transactions of users who are tax residents of the EU. The first information for 2026 must be transmitted in 2027. This is not an online broadcast of a wallet screen. It is another point where crypto transactions become linked to a tax identification number and country of residence.

“Cryptocurrency changes the route of money, but does not erase its biography.”

— Yaroslav Meretskyi, Jurisprudential Consulting Group

Why a crypto card does not make a person invisible

A crypto card creates a convenient illusion: the asset is stored in cryptocurrency, while in a store the payment looks like an ordinary card transaction. However, infrastructure operated by the provider connects these two events. The provider has identified the client, knows the source of funds, records conversions and stores payment history.

In different countries, paying with cryptocurrency itself may be considered a disposal of an asset and create a taxable event. Even when a card purchase is not automatically reported to tax authorities as a separate transaction, the data remains with the issuer, payment organization, bank and crypto provider. During an audit, this information may become part of the overall picture.

Anonymity ends especially quickly when a payment is connected to a person’s identity: an airline ticket, insurance, rental agreement, gym membership, a phone with a warranty card, a vehicle or real estate. At that moment, a digital footprint can easily become a footprint left by your own shoes.

Penalties for undeclared income: Poland as an example

There is no single European rate for undeclared cryptocurrency income. One of the strictest examples applies in Poland, where the 70 percent rate is often incorrectly mentioned in discussions. The law specifies 75 percent. However, this is not a special cryptocurrency tax and not a penalty that is automatically imposed on the entire balance of a wallet.

The Polish provision applies to income that is not covered by disclosed sources or originates from undisclosed sources. The mechanism is triggered when the value of accumulated assets or expenses exceeds confirmed taxable and non-taxable income. The burden of proving the source covering the expenses largely lies with the taxpayer. If, during the proceedings, the source and its amount are established, the income is taxed under ordinary rules rather than under the special 75 percent rate.

The standard Polish cryptocurrency taxation model is much more straightforward. Income from the paid disposal of virtual currency is taxed at a 19 percent rate and reported in PIT-38. Exchanging one cryptocurrency for another is not, by itself, considered a taxable disposal. The problem does not begin with owning USDT, but with the inability to show with what funds the asset was acquired and what documents confirm the expenses.

How consequences differ in other European countries

In other European countries, consequences are calculated differently. Their size depends on the country, type of income, the person’s conduct and the moment when the mistake is corrected.

In Spain, voluntary submission of a late declaration before an official request usually results in a surcharge of 1 percent plus an additional 1 percent for each full month of delay. After 12 months, the surcharge becomes 15 percent, and interest is charged for the subsequent period. If the tax deficiency is discovered by the administration itself, the penalty may amount to between 50 and 150 percent of the unpaid tax, depending on the level of concealment and the use of fraudulent methods.

In France, unpaid tax may be subject to a late-payment interest rate of 0.2 percent per month, an increase of 40 percent in cases of intentional violations and 80 percent in cases of fraudulent actions. Voluntary correction, if the relevant conditions are met, may reduce the additional burden.

In Germany, tax evasion may result in a fine or imprisonment of up to five years, and in particularly serious cases up to ten years. Voluntary disclosure can exclude criminal liability, but only if the information is complete, submitted in time and the tax together with interest is paid. In the United Kingdom, HMRC operates a separate service for voluntary disclosure of unpaid taxes related to crypto assets.

The general principle is the same: correcting the situation before an official inquiry usually provides more procedural opportunities and lower risks than explaining the situation after the information has already reached the tax authority.

PnL on an exchange screen is not a tax return

An exchange may show a user their overall PnL, meaning profit or loss. For tax authorities, this is almost never sufficient. The figure displayed in the interface may not account for other exchanges, deposits and withdrawals, old balances, fees, staking, derivatives, transfers between personal accounts and the rules of a particular country.

Tax calculation does not begin with the Export button, but with determining tax residency for each year. The same transaction may be taxed differently in Poland, Spain, Germany, France or the United Kingdom. Then data is collected from all centralized exchanges, wallets and banks, not only from the platform where the current balance is held.

1. Determine tax residency. It is necessary to identify the country and period in which income arose or a disposal of assets took place. Without this, it is impossible to understand which events are taxable.
2. Export source data. Each exchange should provide deposits, withdrawals, spot trades, derivatives, fees, funding, staking, bonuses and conversion history. It is better to preserve CSV files and official reports rather than only screenshots.
3. Link internal transfers. Movements between personal accounts and wallets should not be counted twice as income or a sale. For this purpose, amounts, dates, fees and txids are matched.
4. Classify events. A sale for fiat currency, payment for goods, token exchange, reward, airdrop, staking and liquidation may have different legal classifications. Classification depends on national legislation.
5. Determine fiat value. For each relevant transaction, the exchange rate in euros, zlotys, pounds or another declaration currency must be recorded at the date and time of the event.
6. Calculate cost basis. FIFO, weighted average cost and other methods are not applied at the user’s discretion but according to the rules of the specific country. Fees and documented expenses are also taken into account according to local law.
7. Reconcile balances. The opening balance plus incoming transactions minus outgoing transactions must explain the final balance. If the accounting model does not match blockchain data and exchange records, the tax declaration will be weak.

DeFi makes calculations more complex, but not impossible

In DeFi, there is no single button that generates a ready-made tax report. First, a list of all addresses and networks must be created. Then bridges, wrapped tokens, swaps, liquidity pools, loans, collateral, liquidations, staking, airdrops and derivative transactions must be reconstructed.

A bridge between networks does not necessarily create profit simply because a token appears on another network. Wrapping an asset, providing liquidity or receiving an LP token may also be classified differently. A loan is not always income, but liquidation of collateral may create a disposal event. This is exactly where tax software is useful as a calculator, but dangerous as a replacement for legal analysis.

For each transaction, it is necessary to preserve the date, time, txid, addresses, asset, amount, fiat value, fee, protocol and assumed tax classification. If one address was used both for personal investments and business activity, this must be separated in the working records.

How to correct undeclared income

The first step is not to urgently submit an amended declaration with an approximate figure. First, the history must be reconstructed and it must be determined where exactly the tax obligation arose.

A practical package usually includes a tax residency map, a complete transaction register, profit and income calculations, documents confirming the original capital, proof of wallet control and an explanation of documentary gaps. After that, the appropriate procedure is selected: a regular current-year declaration, correction of previous periods or a special voluntary disclosure procedure if provided by national law.

Tax regularization and confirmation of the origin of funds are two different tasks. Paying tax does not automatically prove where the original capital came from. Likewise, a clean blockchain history does not replace a tax declaration.

The worst reaction to missing documents is to invent a loan, gift or transaction retroactively. Such a document does not close the gap; instead, it turns a tax issue into a question of the reliability of evidence.

What to prepare before contacting the tax authority or bank

It is necessary to collect the history of all exchanges and wallets, reconstruct bank deposits, separate personal transfers from transactions, determine the source of the initial capital and reconcile the tax calculation with the actual balances. If some documents have been lost, it is better to separate confirmed and unconfirmed amounts and describe the gap directly.

It is also worth checking whether a tax audit has already started, whether an official request has been received and whether the deadlines for voluntary correction have expired. In Germany, for example, completeness and timing of voluntary disclosure are critical. In the United Kingdom, HMRC requires information about the number of transactions, revenue or income, acquisition costs, profit, exchanges used, tax calculation, interest and penalties.

Finally, payments should not be split, third-party accounts should not be used, and only the final clean wallet should not be presented. Tax authorities and compliance departments evaluate not the appearance of the last transaction, but the entire explainable history of capital.

“Tax authorities do not need your seed phrase. They only need to see the gap between official income and real financial activity.”

— Yaroslav Meretskyi, Jurisprudential Consulting Group

Main conclusion

Self-custody gives a person control over an asset, but not tax invisibility. DeFi removes the centralized intermediary from a transaction, but it does not remove the record from the blockchain. A crypto card simplifies spending, but it does not erase conversion events or the connection with the owner.

The longer a person delays the calculation, the more expensive the reconstruction becomes. Therefore, PnL should be prepared before it attracts the attention of tax authorities. And past mistakes are better corrected before an official letter arrives, not after.

Cryptocurrency changes the route of money, but does not erase its biography.

Yaroslav Meretskyi CEO Jurisprudential Consulting Group