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IRS Leverages Technology Tools to Find Taxpayers’ Cryptocurrency

Posted on Jan. 12, 2022

The IRS Office of Fraud Enforcement (OFE) is working with the agency’s examination functions to equip hundreds of agents with software licenses and training to find and trace cryptocurrency transactions.

OFE has been tapping the experiences of the IRS Criminal Investigation division with cryptocurrency “to equip all agents with the necessary tools to detect, trace, and uncover digital assets,” IRS National Fraud Counsel Carolyn Schenck said January 11 on a webcast sponsored by the Federal Bar Association Section on Taxation and Eversheds Sutherland (US) LLP.

Don Fort of Kostelanetz & Fink LLP said the IRS’s internal collaborations on cryptocurrency — many directed by OFE — are especially important because traditional audit and investigation techniques might not find those assets and transactions. “So that’s why the education of the entire workforce, particularly the compliance personnel that are on the front lines, that everybody knows something about crypto even though they think they don’t need to. It’s going to become more and more relevant,” he added.

Schenck agreed. Not only is the IRS acquiring cutting-edge cryptocurrency tracing and analysis tools, but it also recognizes that agents have to look at both parties to cryptocurrency transactions — the senders and the receivers, she said. The key is to analyze the available information to connect the dots among cryptocurrency transactions and taxpayers’ financial and tax filings, she added.

Fort, a former CI chief, also praised the IRS’s efforts to work with private companies doing cryptocurrency tracing work.

Digging for Treasure

Schenck noted that much of OFE’s cryptocurrency work has been funneled through Operation Hidden Treasure. She compared bad actors using cryptocurrency to facilitate tax noncompliance to fugitives fleeing a crime scene by switching trains. “Bad actors shift digital assets from one blockchain to another, hopping chains to cover their trail,” she said.

OFE’s analytics tools are used in Operation Hidden Treasure to track cross-chain activities rather than investigate a single blockchain at a time, according to Schenck. “By analyzing the blockchain and de-anonymizing transactions . . . the IRS is able to track, find, [and] work to seize crypto in both the civil and the criminal setting,” she said.

Schenck reiterated her prediction that the IRS will continue to use John Doe summonses to find unreported cryptocurrency assets and transactions. However, she also pointed out that just because a cryptocurrency exchange like Coinbase Inc. has been served with a John Doe summons doesn’t mean that target is accused of doing anything wrong. The exchanges are served with the summonses only because they are the recordkeepers, she said.

Contemplating the Ifs

Schenck said that while cryptocurrency tools and technology may be complex, the tax treatment isn’t. Taxpayers and their tax advisers should start with a basic premise: “Spending or disposing of virtual currency is generally a taxable event, so get it on the return in some way or another,” she said.

Criminal tax investigations generally take about two years, and cryptocurrency can make them take even longer, according to Fort. CI has been devoting lots of time and resources to those cases, he added.

And while announcements of pure cryptocurrency criminal tax enforcement actions have been sparse so far, according to Fort and Schenck, the tax community can expect to see more relatively soon.

Fort noted that taxpayers considering how to address prior cryptocurrency tax noncompliance have three basic options: voluntary disclosure using the IRS’s guidelines on reporting willful noncompliance, quietly amending prior returns or filing delinquent returns, and doing nothing.

Sarah E. Paul of Eversheds, a former federal prosecutor, said that doing nothing would be a bad idea in the current climate. She explained that the IRS has been carefully and aggressively disseminating the message that cryptocurrency transactions are taxable, so taxpayers will have a difficult time arguing that they didn’t know. Those taxpayers should be deciding whether to fix their noncompliance quietly or loudly, she added.

Schenck agreed that taxpayers with unreported cryptocurrency transactions would be ill-advised to do nothing. The IRS is coming for cryptocurrency tax noncompliance, she warned before reiterating her admonition to just get the assets or transactions on the tax return.

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