The Internal Revenue Service is focusing on cryptocurrency tax evasion with virtual currencies like Bitcoin and nonfungible tokens, employing data analytics to uncover transactions that crypto users assumed were hidden.
The IRS has been training its spotlight on crypto users, adding a question to the front page of the tax form asking taxpayers,”At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” While technologies like crypto and NFTs are designed to be invisible, the IRS is aware that money laundering is being used by some crypto users, and it needs new skills in asset tracing, along with crypto expertise and digital asset auditing.
The IRS is leveraging data analytics technology and artificial intelligence to assist its overburdened staff, especially at a time when the IRS has been facing employee shortages and is stepping up its recruitment efforts. “This is not your grandfather’s IRS,” said IRS Commissioner Chuck Rettig during New York University’s online Tax Controversy Forum on Thursday. “This is an agency that has quite a bit of involvement with respect to data analytics.”
Technology like data analytics and artificial intelligence is helping the agency sift through billions of transactions in the digital world and make the process more efficient for investigators.
“It’s important to know that technology and data analytics and artificial intelligence play a large part in the future of the work that we’re going to be doing at the IRS,” said Jeff Tribiano, deputy commissioner for operations support at the IRS, during the NYU forum.
The crypto world has been changing rapidly, and the IRS has been leveraging technology to keep up with it. “In my 30 years within the government, I’ve rarely seen something evolve as quickly as virtual currency or cryptocurrency,” said Eric Hylton, who was recently commissioner of the IRS’s Small Business/Self-Employed division and previously spent over 20 years at IRS Criminal Investigation. He is now national director of compliance at the tax consulting firm Alliantgroup and director of investigation at the tax whistleblower law firm ZMF.
“I think the Service has done a great job in regards to trying to address this emerging issue,” Hylton toldAccounting Today. Quite a bit of attention has been associated with it. It’s being reported on the 1040, trying to give insight as to how widely cryptocurrency has been adopted. From a compliance standpoint, I think IRS CI has done a great job in really addressing cryptocurrency as it relates to the dark web, but also in moving further in working with a number of firms to really address the potential issue of tax evasion.”
New approaches, including greater computing capacity and artificial intelligence, are helping the IRS analyze and trace digital transactions to the real world. “When I was a criminal investigator, the whole thing was to follow the money, but now with data analytics, it’s all about following the data,” said Jeffrey Cooper, former executive director of international operations at IRS Criminal Investigation and now an executive industry consultant at the business analytics software company SAS.
“From my time with IRS Criminal Investigation, CI took on the challenge of looking at cryptocurrency several several years ago before it was a thing, so to speak,” Cooper toldAccounting Today. “It’s kind of like ‘follow the money.’ Once it became a fiat currency, whether it’s cash or whatever that fiat currency is, once it went into the exchange, we were able to trace it. It is challenging, but the data is still telling the story. Individuals initially thought that they were totally anonymized by being within a blockchain, but we quickly proved them wrong because eventually they wanted to spend their money on something, and when you go back and follow the money trail, that’s helped the agency to really put some enforcement there.”
The Biden administration’s American Family Plan deals with looking at cryptocurrency and establishing new reporting requirements, the threshold being $10,000, he noted. “The Know Your Customer concept that’s in banking follows through to cryptocurrency and follows through to tax administration,” said Cooper. “No matter what they’re doing, though, there’s a trail of data that’s generated, and it’s about putting the analytics behind the data.”
IRS Criminal Investigation has been working with tax authorities in four other countries — Canada, the United Kingdom, Australia and the Netherlands — through a group known as the J5 on tax cases involving cryptocurrency (see story).
“Jeff and I were in charge of IRS CI’s international office,” said Hylton. “We kind of set the groundwork even prior to the J5 being established, working with OECD [the Organization for Economic Cooperation and Development] to do a task force on tax crime and other financial crimes, really working from an operational standpoint. Initially working with OECD, we were coming up with typologies and methodologies to help out countries worldwide to address various emerging threats, and cryptocurrency was on that table. With the J5, they have taken it another step further as far as really addressing the non-compliance issues in cryptocurrency and professional enablers. They have sessions where they come together with these different countries — the Netherlands, U.K., Australia and Canada — in taking some of our top experts in cryptocurrency, pulling it all together and really addressing how you find some of the major issues, either with the dark web or just any tax signature.”
While he was at IRS CI, he was also involved with an operation called Hidden Treasures to identify various signatures within blockchain transactions to detect patterns of tax evasion from a structuring standpoint.
“In looking at the J5, that’s a basic manifestation of the whole-of-government approach with those five countries, and really working together,” said Cooper. “Whether it’s financial crime or even the flow of money, there’s really no more border. The crimes and tax evasion are borderless so those countries got together. Not only are they looking at cryptocurrency as an issue of digital currency, they also have a platform where they’re looking at the technology so that countries can speak to each other. I see the technology, as far as data analytics and AI solutions, helping trace and find the interconnections or those networks so that they then can work together.”
He sees some challenges, however. “Globally there is not one unified understanding or definition of cryptocurrency and how to tax it, what it’s called or what it is,” said Cooper. “In the United States, it wasn’t until 2014 that we classified it as property. Some countries just do not yet, so those regulations haven’t really caught up to the technology that’s out there. In the U.S., whether or not you own cryptocurrency is on the front of the 1040. Basically what that says is that the IRS and the United States government are putting emphasis on that.”
The IRS has also been issuing John Doe summonses to cryptocurrency exchanges like Coinbase and Kraken to disclose information about their anonymous users. “I think you can really see the Service as being pretty aggressive with those John Doe summonses to see if any taxpayers are potentially not reporting all of their [transactions] with currency,” said Hylton. I think we have to take into consideration the market capitalization for this. This hit $2 trillion globally.”
The IRS has needed to work with other countries to trace the transactions across borders.“Tax authorities globally (and not just the IRS) are increasingly looking to data gathering with analytic savvy to improve tax compliance generally,” said Peter Larsen, a principal at Deloitte Tax. “It’s a trend we see not just with respect to crypto. But crypto presents an interesting use case because the crypto ledgers present a public transaction history that the IRS (like anyone else) can access. There’s a lot of data there, but supplementing analytic insights from that public data with information from tax returns, information returns, audits or summons could be of interest to the IRS and other tax authorities.”
The Treasury Department’s Green Book includes proposals from the Biden administration for the IRS to increase its tax enforcement budget to pull in more tax revenue from stepped up tax enforcement, including requiring banks and other financial institutions to report more information about their customers’ accounts.
“Between the commissioner’s recent indication that the IRS will be putting more focus and dollars in enforcement, and the Green Book inclusion of specific proposals for the broadening of third party information reporting, including reporting on cryptocurrency and a new financial account reporting regime we are seeing more evidence of our anticipated trend in the expansion of information reporting in an effort to capture revenue for tax authorities,” said Denise Hintzke, Deloitte global information reporting practice leader.
“If you think about this new proposal from the president and what the Treasury has proposed last month, requiring U.S.-based crypto assets exchanges to report data about their foreign users to the U.S. government and share that information, you kind of have something like a FATCA situation in that regard,” said Hylton. “I think that’s going to be an important aspect of that cross-border exchange if they move forward with that proposal from the Treasury as well. The particularities still remain to be seen, but it really just highlights that not only are we looking at additional reporting for crypto for individuals over $10,000, but also the brokers have to think about…