On the heels of the recent volatility and dramatic expansion of digital asset markets, the IRS—particularly its criminal investigative division—is likely to dedicate more resources to compliance and enforcement efforts, say alliantgroup’s Eric Hylton and Don Sniezek.
The 2022 IRS Criminal Investigation Annual Report sent a clear and direct signal that the IRS’ cryptocurrency enforcement efforts are just beginning. IRS criminal investigations “seized record amounts of data and crypto currency” that included $7 billion in digital assets for FY 2022, according to the report—doubling the total of the preceding year.
The agency has jumped on digital asset enforcement efforts after publishing guidance on tax principles that apply to transactions using virtual currency. This guidance requires taxpayers to disclose their cryptocurrency holdings and is fully described in Notice 2014-21.
The IRS also updated its initial definition of virtual currencies to a more expansive interpretation of digital assets. This broadens the definition from virtual currencies to all things digital, including non-fungible tokens and stablecoins.
Taxpayers should note that the IRS also updated Form 1040 for the 2022 tax year relating to transactions of digital assets. It changed the reporting question on the form to read: “At any time during 2022, did you: (a) receive (as a reward, award, or compensation); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
Further updating this language to the front of Form 1040 sends a clear message that the reporting of digital assets is a high priority. Former IRS Commissioner Charles Rettig testified on multiple occasions that lightly regulated digital assets has contributed significantly to the burgeoning tax gap, which Rettig estimated could be as high as $1 trillion a year.
Congress has provided much needed legislation on infrastructure and tax-and-climate initiatives to combat non-compliance. The new infrastructure law creates the framework for defining a digital asset broker as well as new information reporting requirements.
The IRS is reportedly developing new information on reporting returns, including relevant forms 1099-Digital Asset (1099-DA) and 8300-DA (8300-DA); however, no implementation date has been determined. These forms certainly will increase overall reporting transparency and provide the IRS additional data to inform compliance efforts.
As a part of the new tax-and-climate law, the IRS received an additional $45 billion for enforcement activities, which specifically references “digital asset monitoring and compliance activities” as part of the funding. In an unsurprising move, the new funding has led the agency to create teams that will be ready to take action. The Criminal Investigations Annual Report stated that in FY 2023, it will create the Advanced Collaboration and Data Center, which will improve the agency’s tools for investigating and analyzing digital assets through tracing, monitoring, and basis calculations.
The IRS has also established a new project director of IRS Digital Assets, which will report directly to the deputy commissioner of services and enforcement. This role will oversee the implementation and execution of the new IRS enterprise digital assets strategy and work with a team of leaders across the business units to enhance compliance and enforcement, improve customer service, and establish data and technology protocols.
The IRS has also engaged third parties to help it follow digital asset transactions using forensic tracing of the blockchain, as well as software and technology to help it process digital asset exchange data. In short, the IRS has moved incredibly quickly to assemble its enforcement units, establish a digital asset strategy, and enhance compliance capabilities since weaving digital assets into a taxpayer’s reporting requirements in the last several years.
Looking back at 2022, the US District Court for the Central District of California granted the IRS authorization to issue a John Doe summons on SFOX, a Los Angeles digital currency broker. The summons requests information concerning US taxpayers who took part in transactions involving $20,000 or more from 2016 to 2021.
In a related move, the IRS obtained a court order requiring M.Y. Safra Bank to produce information concerning US taxpayers who might have failed to report crypto transactions to the agency. As part of its petition for the John Doe summons, the IRS noted its interest in customers of SFOX, which had used M.Y. Safra Bank services. These summonses are a part the several others that the IRS has sought related to digital currencies since April 2021, but they’re also what Criminal Investigations Chief Jim Lee has described as the development of hundreds of cryptocurrency cases.
The IRS already found success with some of its enforcement actions in 2022, including Bitqyck founders and “crypto actors” Samuel Mendez and Bruce Bise being sentenced to a combined eight years in prison for tax evasion. The arrest of Ilya Lichtenstein and Heather Morgan for conspiracy to launder cryptocurrencies also made the IRS’ “win list” for 2022.
Taxpayers involved with digital assets will need to be diligent about their reporting. The IRS will only further bolster its enforcement units, as its Office of Cyber and Forensic Services and other teams continue to get their bearings on these new technologies.
Specifically, Lee has stated that the IRS intends to being on at least 500 new employees, including 360 special agents, to support the agency’s enforcement actions. Civil enforcement efforts are also anticipated to increase. These efforts will run in tandem with other government agencies and their crypto-enforcement efforts, including the Securities and Exchange Commission’s doubling of its Crypto Assets and Cyber Unit as well as the Department of Justice’s Digital Asset Coordinator Network.
IRS Criminal Investigations is also collaborating with international partners through The Joint Chiefs of Global Tax Enforcement (J5), a joint venture with the criminal tax authorities from Australian Taxation Office, the Canadian Revenue Agency, the Dutch Fiscal Information and Investigation Service, Her Majesty’s Revenue and Customs from the UK. The J5 spearheaded a challenge in which digital asset experts from each country join forces to establish new ways to combat tax fraud and money laundering in the wake of new emerging threats inherent in the blockchain technology related to NFTs and decentralizing finance.
Since 2022 is ending with record IRS enforcement numbers related to digital currencies, including stable coins and NFTs, it’s a safe bet to assume 2023 will be another banner year.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Eric Hylton is the immediate former commissioner for Small Business/ Self-Employed at the IRS and the current director of compliance at alliantgroup.
Don Sniezek is a former IRS examination executive and is a senior technical adviser at alliantgroup.
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