The Internal Revenue Service has picked TaxBit, a Salt Lake City-based company, as a subcontractor to help it do data analysis and tax calculations for audits of taxpayers with cryptocurrency.
TaxBit’s tax automation software is already being used by companies, consumers and other government agencies, but the deal with the IRS represents a major step in demonstrating how seriously the IRS is taking tax compliance for users of digital and virtual currencies like Bitcoin, Ether and Dogecoin. TaxBit will soon be working with the IRS, and its reports will be shared not only with the IRS, but with the taxpayers themselves, as well as the CPAs and attorneys who represent them during audits.
The IRS has been cracking down on cryptocurrency users who fail to report their gains, adding a question to the top of the 1040 form in recent years asking if any time during the previous year, they received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency. The agency won a high-profile court case in 2018 against the popular crypto exchange Coinbase to get access to their customer information through John Doe summonses. Last week a federal court in California authorized the IRS to serve a John Doe summons on another popular cryptocurrency exchange, Kraken, and its owner Payward Ventures. TaxBit could be finding itself poring over the information made available through these efforts. However, much of it will come from the standard processes used by the IRS for selecting returns that set off red flags for further examinations and audits.
“The IRS will go through and pick these audits based off of either their random selection or red flags,” said Seth Wilks, director of government relations at TaxBit. “It’s not necessarily generated because of crypto, but once they get the audit and they discover that there is crypto activity and really substantial crypto activity, that’s when they come to us. They collect the data from the taxpayer, and then the IRS gives us that information. We run data analysis and tax calculations, and provide an expert report on the findings.”
The effort fits in with the IRS’s increased emphasis on ensuring better tax compliance among crypto users. “I do think it shows that holistic approach that the IRS is taking because they are taking this seriously and they are investing in the right tool to make sure that they understand how it works and that they can do proper calculations on the data,” said Wilks.
It also shows the extent to which the IRS is adjusting to the increasing use of cryptocurrency by investors. “This is a milestone moment for the cryptocurrency industry,” said TaxBit CEO Austin Woodward in a statement Tuesday. “It indicates regulators are embracing the asset class, but doing so in a way that ensures a straightforward approach to conform with existing regulations. We believe this is an important step for the enablement of widespread cryptocurrency adoption."
TaxBit will be helping the IRS scrutinize returns going back several years. “It really is case by case,” said Wilks. “These really can range from 2016 or 2017 and forward. Typically, if you think about an IRS audit cycle, they don’t start auditing taxpayers until usually a couple of years after they’ve filed, so these are not necessarily audits that are coming from 2020 or 2019 activity. These are really from the last few years.”
The IRS did not respond to a request for comment, but it has done some preliminary work already with TaxBit, according to Wilks. “We have already worked some one-off cases for them, but the big contract will begin execution very soon,” he said.
The software should help automate the process for IRS auditors of determining how much money was made from crypto transactions. It will generate a report that will go to the IRS, and in turn to taxpayers. “They’re just looking to get an accurate view of the gains and losses,” Wilks explained. “If you imagine a CPA trying to get through a million lines of data and calculating gains and losses using a FIFO methodology or something, that would take an unrealistic amount of time, so the idea is that we have technology that can do that in a matter of minutes. But beyond that we have CPAs and attorneys who work here and who can then look at that information and we can get further insights into what may be missing. This report is provided to the IRS, but it’s also reported to the taxpayer, so it’s a resource on both sides to help them make sure that they’re getting a complete picture.”
Taxpayers, as well as their accountants and attorneys, may start seeing the reports as soon as next year. “Typically in an audit situation they will either be represented by a CPA or an attorney,” said Wilks. “They can self-represent, of course, but it’s usually a conversation with the field agents and with us, so the exact methodology of how they communicate, we can’t really opine on, but my understanding is that the report is provided to both taxpayers as well as the IRS.”
It may take a while for the IRS to process the reports, given the backlog of work at the agency this tax season due to the pandemic and the extra work of processing Economic Impact Payments and providing guidance on recent tax laws.
“From our understanding there’s a backlog of cases,” said Wilks. “Obviously, working with the IRS, there are extensive background checks and security clearances that you have to go through. We’ve cleared all that and really it’s now just getting the administrative side to send us the cases and the data.”
He expects TaxBit to start receiving the initial data and to begin sending the reports by early next year. “We’re actually expecting them any day now at this point, so it will be within the next 12 months,” said Wilks. “If you think about it, these are cases that have already been flagged and they’ve had a lot of work done on them even before we see them. Obviously an audit isn’t always just specific to the crypto side. They’re going to look at all of their income sources and all of their reporting, so crypto is just one aspect of the overall audit.”
TaxBit also offers its technology to accounting firms, businesses and consumers. Its TaxBit Enterprise and TaxBit Consumer products help with cryptocurrency tax reporting to assist users with their investments and use of cryptocurrency. TaxBit is also developing an accounting ERP system that it plans to launch later this year, and it has plans for international expansion.
“This is just one vertical we’re involved in,” said Wilks. “We work with consumers. We work with the enterprise level. This would be exchanges, and we also build out ERP accounting solutions for cryptocurrency. We work with consumers to help them aggregate all of their data and run the tax calculations and fill out the proper forms. On the enterprise side, we work with exchanges to help them with their information reporting, 1099 and 1099-MISC filings, and then we also provide technology that are kind of wealth management tools, but specific to taxes so that people can see tax consequences before they execute a trade.”
The company has been processing millions of transactions for customers even before the IRS deal begins. “It’s a case by case basis, but these are anywhere from hundreds of thousands and even into the millions,” said Wilks.
The technology will now be helping the IRS audit various types of cryptocurrency, including Bitcoin, Dogecoin and Ether. “With these cases, these are being traded on multiple exchanges,” said Wilks. “They’re dealing with dozens of currencies. They’re very technical as far as the breadth that they cover.”
