Don't Mess With Taxes

Photo by Alesia Kozik

In the last 15 years, virtual currency has grown into a trillion-dollar industry. It’s exponential growth is reflected in the number of types of virtual currency. Since April 2020, the crypto options have jumped from 5,000 to more than 26,000 by July 2023.

The Internal Revenue Service has faced digital currency tax compliance complications from the get-go. The challenges have increased as the sector and its advocates have grown.

Evasive crypto transactions and how effectively the IRS deals with the taxpayers who employ them is the subject of a recent Treasury Inspector General for Tax Administration (TIGTA) report, dated July 10 and released Monday, July 15.

TIGTA’s bottom line? Despite some success, the IRS’ crypto compliance efforts can be improved.

Crypto transaction complications: In addition to the growing number of crypto owners, these digital currency fans are increasingly using it a payment method.

The IRS, however, does not recognize virtual currency as traditional currency. Digital assets are just that, property. So, under U.S. tax law, each time a taxpayer uses virtual currency as a medium of exchange it potentially creates taxable capital gains consequences.

“Making payments with virtual currency has emboldened taxpayers to move money offshore, purchase illegal goods and services, and carry out other nefarious activities. Users may feel there is the possibility of avoiding tax reporting obligations,” according to TIGTA.

Third-party reporting helps, …: TIGTA’s review also found that when it comes to following tax laws, taxable virtual currency and other crypto transactions operate like traditional income in a couple of familiar ways.

Crypto tax compliance is higher when taxable amounts are subject to information reporting. IRS data for tax years 2014 through 2016 show that when there is income information reporting from third parties, such as on the various 1099 forms, tax compliance exceeds 90 percent. With no third-party income information available to the IRS, tax compliance is 55 percent.

Compliance increases even more when the transactions are subject to withholding.

However, the IRS has been slow in putting such reporting mechanisms for digital assets in place.

… but IRS slow to implement reporting: Provisions in the Infrastructure Investment and Jobs Act of 2021 requires brokers to file an information return for digital assets transactions in a calendar year.

To facilitate this reporting, the IRS created a new information form — Form 1099-DA, draft excerpt below — to report the information needed to calculate gains (or losses) on transactions.

See more tax forms and more about them at Tax Forms 2024.

But actual implementation of mandated digital asset transaction reporting by brokers is behind schedule. The TIGTA report notes that while the infrastructure act called for it to apply to digital transactions after Jan. 1, 2023, IRS proposed regulations call for gross proceeds reporting after Jan. 1, 2025, and for basis reporting after Jan. 1, 2026.

“The proposed two-year implementation delay will hinder efforts to regulate the digital asset industry and may result in lost revenue and taxpayer burden,” said the report.

Civil and criminal investigation efforts: IRS Criminal Investigation has taken advantage of analytics tools to address virtual currency noncompliance. During Fiscal Years 2018 to 2023, IRS CI investigated 390 cases involving virtual currency/digital assets. Investigators recommended 224 of those cases for prosecution.

However, the IRS’ civil examination enforcement efforts focused on digital assets are mostly indirect and negligible, said TIGTA.

And Operation Hidden Treasure, which the IRS created to identify taxpayers who omit digital assets from their tax returns, has had negligible results. TIGTA found the effort has been limited to the acquisition of tools and training, rather than pursuing taxpayers.

“The project's charter did not include any specific enforcement deliverables pertaining to either criminal investigation or civil examination results and success statements identifying what it sought to achieve.

TIGTA recommendations: The TIGTA report offers IRS three suggestions on how it can its improve digital asset tax compliance efforts.

Unfortunately, the first two recommendations are heavily redacted. It’s difficult to tell exactly what the tax agency watchdog thinks the IRS should do.

The third recommendation, though, is unredacted.

Here, TIGTA suggests that IRS’ Large Business & International (LB&I) Division, Small Business/Self Employed (SB/SE) Division Examination, Criminal Investigation, Research Applied Analytics and Statistics (RAAS), and the Digital Assets Initiative Project Office develop a compliance plan that includes the use of newly-developed Form 1099-DA data, case identification, and case selection of digital asset cases.

"The IRS agrees that digital asset compliance enforcement can be improved," wrote IRS chief tax compliance officer Heather Maloy 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] enables us to hire more enforcement personnel as well as invest in data analytics and technology solutions to support compliance efforts. We will use enhanced data, analytics and technology tools to select compliance cases based on highest risk of noncompliance."

Tax Felon Friday: When the IRS nabs a digital asset scofflaw, you can read about here on the ol’ tax blog, as was the case last February in my post Texas man charged in apparent first-ever criminal crypto capital gains tax case.

In the meantime, if you want to catch up on all sorts of tax miscreants, the ol' blogs' special Tax Felon Friday page is a good place to start.

And if you want more tax crime posts, notably those that were published long before I gave them a special end-of-week feature, you can peruse, what else, the tax crimes category. You'll find this post at the top of that collection right now, so just scroll down for more.

You also might find these items of interest:

• IRS unveils draft 1099-DA for future digital asset transaction reporting
• IRS offers guidance on how to answer the tax return digital assets question
• 'Bitcoin Jesus' accused of $48 million in tax evasion related to the crypto currency

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