The IRS is focused on enforcing tax compliance among crypto investors. Learn the four primary enforcement approaches they use to pursue you. (TCDS-01)
The IRS is interested in crypto investors.
In recent years, the Internal Revenue Service (IRS) has been increasing its focus on tax compliance among crypto investors. With the cryptocurrency market gaining significant traction, the IRS sees a substantial opportunity to collect additional tax revenue. Let's delve into the IRS's approach to crypto investors and explore four enforcement methods they can employ to ensure tax compliance.
Their focus on crypto tax compliance.
The IRS is the revenue-generating arm of the US government, responsible for collecting approximately $5 trillion in revenue annually. In April 2021, the IRS commissioner testified before Congress, stating that with proper funding, the IRS could potentially bring in an additional $1 trillion, mainly from digital asset owners. Congress and the White House accepted this challenge, approving an $80 billion supplemental funding to the IRS, with $46 billion specifically earmarked for enforcement activities related to digital asset tax compliance.
Understanding crypto investor compliance.
Industry observers estimate that there are approximately 30 to 33 million crypto owners in the US. However, preliminary data suggests that only around 8 million taxpayers checked the "yes" box on the virtual currency question in their tax returns, indicating compliance. This means that around 22 million or roughly 70% of crypto owners are not fully compliant. The IRS views crypto investors as potentially wealthier than average taxpayers, making them an attractive target for additional tax revenue.
Let’s look closer at the 22M.
The first category is puny investors. They bought $100 of BTC on Coinbase a couple of years ago to boast that they had BTC. But they have done nothing further. They check “no” on the virtual currency question because they forgot.
The second category is people who filed a tax return but didn’t report their crypto income. They are hiders. They think the IRS won’t find them. They checked “no” on the question to not attract IRS attention. Technically this is called tax fraud.
The third category is people who didn’t even file a tax return. They are trying to live under the radar and off the grid. They may say taxes are wrong, the government is evil, or anarchist-like comments. Technically, not filing when you should file is called tax evasion.
A "voluntary" tax system.
The U.S. income tax system is considered a voluntary system because taxpayers voluntarily disclose to the government their income and pay their taxes. The IRS considers people who willfully conceal their income to avoid paying taxes as a threat to society. If they hide enough income, it's considered a felony.
IRS management thinks there are potentially tens of millions of taxpayers engaged in willful tax fraud or evasion.
IRS enforcement methods.
The IRS employs four primary enforcement methods to ensure compliance among crypto investors.
Of the 8M taxpayers checking “yes” to the virtual currency question, the IRS suspects a large percentage of them underreported their crypto income. The IRS enforcement method for these taxpayers is auditing. The consequences of an audit are to pay additional taxes owed, a 20% accuracy penalty, and interest.
The biggest consequence of an audit is prolonged dread. An audit can take one to four years to resolve. This can cause significant anxiety, financial fear, marital tension, and even divorce.
The IRS sees these non-filers and hiders as engaging in intentional and willful non-compliance and evasion. The IRS enforcement method for these people is criminal investigation and prosecution. The punishment for tax fraud or evasion is up to $250,000 and three years in prison per year of fraud or five years per year of evasion.
Anti-Money Laundering (AML) law enforcement.
Another method of enforcement the IRS can use is AML laws. The US anti-money laundering laws required US persons to report the maximum balances in USD kept at foreign financial institutions. Failure to report the maximum balances is subject to steep fines.
This is a powerful tool for the IRS because reporting the maximum balances held anytime during the year at foreign exchange is relatively quick and easy to prove or disprove. The penalties can be assessed in addition to whether the taxpayer reported his crypto income on his return or not.
The IRS has yet to use this approach for crypto-enforcement for two reasons:
- The anti-money laundering laws were written before digital assets were developed, so the language of sections 31 USC 1010.350 and 26 USC 6038D must be extrapolated to apply to crypto institutions. I suspect that the IRS Chief Counsel’s Office is not ready to argue the issue before a judge in court yet.
- Secondly, the IRS has lost several significant court battles trying to enforce AML penalties. It is believed that the Treasury Department will pursue changes to these laws to get clearer penalties. Once that happens, I believe AML enforcement will become the preferred method of compliance enforcement because it is lucrative and easy to prove.
Finally, the law offers rewards of 10% to 30% for whistleblower leads resulting in substantial collections. In the past, the IRS has denied payouts on whistleblower claims. They have been successfully sued by whistleblowers seeking their rewards.
However, in recent meetings of the J5, the five nations cooperating on digital asset enforcement, the J5 board recommended that the IRS and other tax authorities become more receptive to and encouraging whistleblowers in the crypto space.
The IRS might see the Whistleblower as a more fruitful program to support in the future. So, be careful whom you tell about your non-compliance.
Which enforcement approach does the IRS prefer?
The AML enforcement will be a powerful tool once Congress, the Courts, and the IRS agree on interpreting the law and penalties. And increased use of the Whistleblower program will require an attitude change inside the IRS.
The audit approach is actively used, but it is labor-intensive and expensive. It involves disputes over how to interpret trading transactions. Whereas, the criminal approach is much easier and less expensive then audits.
Criminal enforcement is easy.
To enforce criminal statutes, the IRS only needs to show that the person had taxable crypto-related income. Since the person is likely to be a non-filer or a hider, there is little argument over the facts. Once indicted, the person focuses on getting a plea deal rather than protesting his innocence.
Another benefit for the IRS of using criminal enforcement is that they get to publicize the indictment. Publicity is a major tactic the IRS uses to scare the public into compliance. Expect to hear more new stories of crypto traders indicted for tax evasion and fraud.
How will the IRS use its extra $46B?
An estimated $46B in funding is earmarked to increase enforcement of digital asset tax compliance. This additional funding makes digital asset tax compliance the number one enforcement priority for the IRS for the next seven years.
The IRS Commissioner announced intentions to get an additional 4,800 criminal investigation agents. That would triple the number of criminal investigators.
The Department of Justice announced plans to hire another 150 lawyers to handle cryptocurrency enforcement. They will also use the funds to hire contractors and professionals to build up the IRS investigator machine.
Let’s talk about the rabbit hole.
Someone who didn’t report their crypto income last year will likely not report it this year. They are afraid to start reporting because the IRS will find out about the past years. Each year they fall further into the hole. Soon they reach a point where they could never pay off the past taxes if they did report, so why report?
If you’re someone who haven’t been reporting any cryptocurrency income should get professional advice about getting into compliance.
My staff and I have done over 1,200 tax amnesty returns and helped hundreds of taxpayers correct past unreported income and anti-money laundering reports. Today is the day to start getting compliant.
Schedule a private consultation to build a strategy toward returning to compliance.
DISCLAIMER: Opinions and perspectives of the author, host, and guests. It should not be construed as U.S. taxpayer advice. There are often multiple interpretations of tax law. Various strategies may be suited to specific individuals and for particular situations. Seek out professional tax, legal, or financial advice from CryptoTaxAudit or from other reputable companies.