Cryptocurrencies have increasingly become synonymous with illicit activities, lending anonymity to acts ranging from insider trading to more severe financial crimes. The Treasury Inspector General for Tax Administration recently released a report highlighting significant gaps in the IRS’s enforcement of cryptocurrency tax compliance. The argument is that improving compliance could not only increase tax revenue but also bolster the transparency of financial transactions, thus undermining illegal activities.
Effective enforcement could net much more than the estimated $50 billion annual crypto tax gap and disrupt the myriad black market activities dependent on digital currencies, as discussed in Bloomberg Tax. The IRS’s civil enforcement attempts have been criticized as “indirect and negligible,” with only 390 cases related to digital currency investigated between 2018 and 2023, of which 224 were recommended for prosecution.
An IRS initiative, “Hidden Treasure,” aimed to address these issues but has largely focused on internal training and tool acquisition rather than directly pursuing tax evaders. Given the exponential growth in digital currency usage, the IRS’s current efforts are insufficient to manage the scale of noncompliance.
The enhanced enforcement would contribute not only to substantial tax revenue collection but also significantly disrupt these illicit activities. For example, cryptocurrency is tied to drug and human trafficking, ransomware, and even terrorism, highlighting the critical need for regulatory oversight. The IRS has even offered a $625,000 award for innovative solutions to crack the anonymity of Monero, a $3 billion slice of the $1.7 trillion cryptocurrency market.
A concerted effort that includes advanced data analytics and collaborations with blockchain analytics firms could help the IRS feel more proactive and effective in this regard. Data from Form 1040 should be cross-referenced against information from crypto exchanges and other sources. High-income individuals should be audited first as they may offer the highest return on investment in terms of compliance efforts.
Ultimately, the IRS must leverage the data it already has while fostering collaborations with other agencies to close the crypto tax gap. The real challenge lies in contextualizing this data to link taxes owed to individual taxpayers, thereby disrupting black market dependencies on cryptocurrency’s perceived anonymity.
Cryptocurrency exchanges already provide crucial information on traders, and large cash transactions are reported by traditional banks. The IRS, using context and pattern recognition through advanced computational technologies, could effectively tackle the compliance issue.
Andrew Leahey, a tax and technology attorney, aligns with this view, suggesting that contextualizing existing data is key to closing the crypto tax gap. For further insights, read more by Andrew Leahey.