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IRS Cryptocurrency Tax Compliance May Become Stricter
The Internal Revenue Service could do more to crack down on tax delinquency by users of virtual currency or digital assets, a new report suggests.
THE relationshipreleased Monday by the Treasury Inspector General for Tax Administration, acknowledged that the IRS had established “Operation Hidden Treasure” to identify taxpayers who omitted digital assets, such as cryptocurrency, from their tax returns. However, the operation was limited to acquiring tools and training, rather than prosecuting taxpayers. The project’s statute did not include specific enforcement objectives, in terms of criminal investigations or civil examination results, or statements identifying what it was seeking to accomplish.
The anonymity of virtual currency and the fact that cryptocurrency trading platforms do not routinely report virtual currency transactions to the IRS complicate enforcement efforts, TIGTA noted.
Internal Revenue Service IRS Headquarters in Washington, DC
Stefani Reynolds/Photographer: Stefani Reynolds/B
“Enforcing taxes on virtual currency transactions is a challenge for the IRS because it does not have a clear window into taxpayers’ virtual currency investments or transactions because their names are typically not directly associated,” the report said. “Furthermore, the IRS does not consistently receive reports from trading platforms about virtual currency transactions.”
The number of taxpayers using cryptocurrency as a means of payment is growing. Between April 2020 and July 2023, the number of virtual currencies increased by 420%. Since the IRS considers virtual currency to be property, any time a taxpayer uses cryptocurrency as a means of exchange, it potentially creates tax consequences.
“Making payments with virtual currency has encouraged taxpayers to move money abroad, purchase illegal goods and services, and engage in other nefarious activities,” the report said. “Users may believe there is an opportunity to evade tax reporting obligations.”
The IRS Criminal Investigation Division has leveraged analytics to address virtual currency noncompliance, the report noted. From fiscal years 2018 to 2023, the IRS CI investigated 390 cases involving virtual currency or digital assets, with 224 of those cases recommended for prosecution.
On the civil side, the IRS’s civil enforcement efforts that focus on digital assets like cryptocurrencies are “mostly indirect and negligible,” according to TIGTA. Form 1040 includes a question about digital assets, but the publicly released version of the report is partially redacted, so it’s unclear how the information from that question is being used.
The Infrastructure Investment and Jobs Act of 2021 requires brokers to file an informational return listing all digital asset transactions that occurred during the year, so the IRS created a new informational form, Form 1099-DA, to report the information needed to calculate gains or losses on those transactions. However, while the law is set to go into effect for transactions after January 1, 2023, the proposed regulations are effective for transactions after January 1, 2025 for gross proceeds reporting and January 1, 2026 for basis reporting. The proposed two-year implementation delay will likely hinder efforts to regulate the cryptocurrency industry and result in a loss of tax revenue.
TIGTA recommended that the IRS develop a compliance plan that includes the use of Form 1099-DA data, case identification, and digital asset case selection. Other recommendations were mostly censored.
“The IRS agrees that digital asset compliance enforcement can be improved,” Heather Maloy, IRS tax compliance officer, wrote in response to the report. “IRS compliance efforts are still recovering from years of underfunding. The multi-year funding provided by [the Inflation Reduction Act] allows us to hire more law enforcement personnel and invest in data analytics and technology solutions to support compliance efforts. We will use advanced data, analytics, and technology tools to select compliance cases based on the highest risk of noncompliance.”
Accounting Today recently interviewed Don Fort, former head of IRS Criminal Investigation and now chief business officer of IVIX, an AI-powered platform designed to help tax authorities fight financial crime and tax noncompliance, on the sidelines of the NYU Tax Controversy Forum in New York in late June. He explained how the IRS CI is using the technology to uncover unreported crypto transactions.
“At the moment, there is no information on cryptocurrencies,” Fort said. “There is a little bit, but it’s not the government-mandated 1099, and it won’t go into effect until January 2025 unless it gets deferred, which means you won’t see the 1099 until the 2026 filings. The previous commissioner and I think this commissioner, and many IRS officials, have talked about the fact that they believe part of the tax gap is attributed to cryptocurrencies and cryptocurrency and unreported capital gains, and buying and selling goods and services in cryptocurrency. But how do you find out who these people are? The blockchain is open and available to the public, but it doesn’t tell you the name of the person, so how does the IRS know that the person lives in the United States? How does a state know that the person resides within their state borders? This is an area where cryptocurrencies, because they are very technological, generally leave footprints behind that you can make connections with, whether it’s buying NFTs or something like that. Many of these people, even if they don’t want a tax authority to know who they are, leave footprints behind them.”
Social media apps and other sites can help analytics tools make these connections.
“People can leave a footprint that you might be able to triangulate and figure out who someone is,” Fort added. “There aren’t a lot of people out there that can generate leads in the cryptocurrency space. There are a lot of people who can track, but identifying who people are, aside from whistleblowers and John Doe citations, how do you actually figure out who these people are? I think that’s one of the most valuable areas we’re working in right now.”