$10,000 crypto tax-reporting rule won’t change much

The administration of President Joe Biden wants the Internal Revenue Service to do a better job of collecting from taxpayers who trade cryptocurrency. But the Treasury Department's new proposal to require reporting to the IRS when businesses receive at least $10,000 in a virtual currency won't do much to improve tax compliance.

According to the Treasury, businesses should have to report large crypto (and cash) transactions to deter money laundering and tax evasion. The use of digital currencies like Bitcoin is expected to grow, and a separate Biden proposal to require financial institutions to send the IRS information detailing bank account flows would make crypto transactions a tempting way to hide business income if not reported, the thinking goes.

That all may be true. But the new reporting requirement for businesses, and a call for crypto exchanges to report on customers' accounts, ignores a much easier, more effective way to narrow the $600 billion difference between what Americans owed in taxes and what the IRS actually collected in 2019. And that's for the IRS to provide better, faster and more informed guidance for crypto taxpayers.

Since investors first started trading cryptocurrencies a decade ago, the IRS has been slow to define the rules of the road. It didn't weigh in until 2014 on whether crypto would be treated for tax purposes as property or as currency. Not surprisingly, from 2013 to 2015, fewer than 1,000 taxpayers reported any crypto gains each year, according to the IRS.

The latest crypto guidance was published in 2019, practically a lifetime ago in the crypto world. During the past two years, activities such as staking, where coins are locked in a crypto wallet, and the trading of non-fungible, or unique, tokens has exploded. So has the use of decentralized finance, where crypto holders engage with each other directly. Those who want to comply don't know how to, and scofflaws seem to be getting a free pass.

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There's a FAQ on the IRS's website, but that's not legally binding tax law. Even worse, the information provided is sometimes too general, leaving taxpayers to infer what the IRS might think.

The agency tried to get a better handle on crypto transactions with the 2020 tax form, but even that was bungled.

The form included a prominent check box asking whether taxpayers had received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency. Most taxpayers took that to mean they didn't have to check yes if they had bought crypto with dollars and held onto it (and the IRS FAQ confirmed that interpretation). But that seems to be at odds with what the IRS had said previously.

Another way for the IRS to boost compliance would be to have more of a presence where misinformation about the tax treatment of crypto is being disseminated. A quick look at Facebook and Reddit makes it clear that there's still the false perception that crypto holders only have to pay taxes when they cash out to hard currency. (Since crypto is considered property, like stocks, investors are subject to capital gains taxes whenever it's sold or traded.)

Finally, there's an even bigger problem looming. Many crypto investors use decentralized exchanges such as Uniswap to trade cryptocurrencies. Those exchanges, many of which aren't based in the U.S., don't require any registration or account information.

While the IRS is working to get more information about users from U.S.-based exchanges, it seems to be unaware of taxable events that are happening on decentralized exchanges. Still, thanks to the blockchains that make digital currency possible, databases of crypto transactions already exist.

Biden says he wants to give the IRS a lot more money for enforcement. It would be prudent to earmark some of it for hiring people able to analyze blockchain transactions, and for a broader effort to make the IRS savvy enough about cryptocurrencies to provide more informed guidance. That may prove to be the quickest way to plug the crypto tax gap.