IRS Tightens Grip on Crypto: Are Your Transactions Being Watched?

IRS Increases Scrutiny of Crypto Transactions

The IRS has been steadily increasing its surveillance of cryptocurrency investors since 2017. Initially focusing on specific high-value transactions, the agency is now casting a wider net, requesting user records from major exchanges and employing sophisticated blockchain analytics.

Key Developments:

• Expanded Surveillance: The IRS is leveraging "John Doe summonses" and advanced blockchain analysis to monitor crypto transactions in real-time.
• Targeting Exchanges: Major platforms like Coinbase, Kraken, and Circle have been targeted with summonses to provide user data.
• Increased Enforcement: Crypto seizures by the IRS reached $3.5 billion in fiscal year 2021, representing a significant portion of total asset seizures.
• High Non-Compliance Rate: The IRS estimates a 75% potential non-compliance rate among taxpayers identified through digital asset exchanges.

"John Doe Summonses": A Powerful Tool

The IRS uses "John Doe summonses" to obtain information about individuals whose identities are unknown. To obtain these summonses, the IRS must demonstrate that it is investigating an ascertainable group, has a reasonable basis to believe that non-compliance with tax laws exists, and that the information is not readily available from other sources. However, the legal threshold for approval is relatively low, offering limited protection for crypto users.

Impact on Crypto Firms and Users

The broadened use of John Doe summonses increases the compliance burden for crypto firms. Any prior non-compliance, even inadvertent, is more likely to be detected, potentially leading to penalties or even criminal referrals. This shift represents a move towards an "opt-out" model of crypto tax enforcement, where compliance is automatically assumed.

The Future of Crypto Tax Reporting

The upcoming 1099-DA reporting regime aims to reduce historical reporting mismatches that have triggered erroneous IRS notices. This new system will require gross proceeds reporting for dispositions in 2025 and basis reporting for covered securities beginning in 2026. However, discrepancies may still occur if exchanges fail to properly capture cost-basis information.

Key Takeaways:

• The IRS is actively monitoring cryptocurrency transactions.
• Crypto exchanges are under increasing pressure to comply with IRS requests.
• Crypto investors should ensure they are accurately reporting their crypto activities to avoid potential penalties.