The Internal Revenue Service could be doing a better job of cracking down on tax noncompliance by users of virtual currency or digital assets, according to a new report.
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The anonymity of virtual currency and the fact that crypto trading platforms don't consistently give reports to the IRS on virtual currency transactions complicates enforcement efforts, TIGTA noted.
"The tax enforcement of 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 generally are not directly attached," said the report. "Further, the IRS does not consistently get reports from trading platforms on virtual currency transactions."
The number of taxpayers who use crypto as a payment method is growing. Between April 2020 and July 2023, the number of virtual currencies increased 420%. Because the IRS regards virtual currency as property, whenever a taxpayer uses crypto as a medium of exchange, that potentially creates taxable consequences.
"Making payments with virtual currency has emboldened taxpayers to move money offshore, purchase illegal goods and services, and carry out other nefarious activities," said the report. "Users may feel there is the possibility of avoiding tax reporting obligations."
The IRS's Criminal Investigation division has taken advantage of analytics tools to address virtual currency noncompliance, the report noted. From fiscal years 2018 to 2023, 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 examination enforcement efforts that focus on digital assets such as crypto are "mostly indirect and negligible," according to TIGTA. Form 1040 does include a question about digital assets, but the publicly released version of the report is partially redacted, so it's unclear how this information from this question is used.
The Infrastructure Investment and Jobs Act of 2021 requires brokers to file an information return listing any digital assets transactions during the year, so the IRS created a new information form, Form 1099-DA, to report the info needed to calculate gains or losses on such transactions. But while the law is supposed to take effect for transactions after Jan. 1, 2023, the proposed regulations are effective for transactions after Jan. 1, 2025, for gross proceeds reporting and Jan. 1, 2026, for basis reporting. The proposed two-year implementation delay will probably hamper efforts to regulate the crypto industry and result in lost tax revenue.
TIGTA recommended the IRS develop a compliance plan that includes the use of Form 1099-DA data, case identification and case selection of digital asset cases. Other recommendations were mostly redacted.
"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."
Accounting Today recently interviewed Don Fort, former chief of IRS Criminal Investigation and now chief business officer of IVIX, an AI-powered platform designed to help tax authorities fight financial crimes and tax noncompliance, on the sidelines of the NYU Tax Controversy Forum in New York in late June. He explained how IRS CI is using technology to ferret out unreported crypto transactions.
"With crypto right now, no information report," Fort said. "There's a little bit, but it's not the government-mandated 1099, and that won't take effect until January 2025 if it doesn't get delayed, which means you won't see the 1099s until 2026 filings. The prior commissioner and I think this commissioner, and a lot of IRS officials, have talked about that they believe part of the tax gap is attributed to crypto and unreported crypto and capital gains, and buying and selling goods and services in crypto. But how do you find out who these people are? The blockchain is open and publicly available, but it doesn't tell you the person's name, so how does the IRS know that the person even lives in the United States? How does a state know that the person resides within the confines of their state? That's an area where crypto, because it's very technologically heavy, people do generally leave footprints behind that you can make connections, whether they're buying NFTs or things like that. A lot of these people, even though they may not want a taxing authority to know who they are, leave footprints behind."
Social media apps and other sites can help analytical tools make those connections.
"People can leave a footprint that you may be able to triangulate and figure out who somebody is," Fort added. "There's not a lot of people out there that are able to generate leads in the crypto space. There's a lot of people that can trace, but identifying who the people are — short of whistleblowers and John Doe summonses — how do you really find out who these people are? I think that's one of the more valuable areas that we're working in now."
