Last week, the Treasury Department issued a report laying out President Joe Biden’s plans for improving tax compliance. One topic the report addressed was the growing crypto economy and its potential use for tax evasion. It recommended that the IRS receive additional funding to upgrade its information technology and that all business transactions involving cryptocurrency exceeding $10,000 should be reported.
This is just a proposal and is not law. Although this can give a sneak preview of legislation yet to come.
Reporting requirements are nothing new although they have had mixed results. Most people know that banks must report transactions exceeding $10,000 with some exceptions and generally have accepted it. Some people thought they could be slick by depositing multiple $9,999 transactions to get around this law. This does not work since the law requires reporting multiple related transactions that total $10,000 or more. Not only that, these multiple transactions could result in banks may filing a suspicious activity report which can lead to criminal penalties for illegal structuring transactions.
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And if you traveled overseas, you probably saw the form where you must declare whether you are carrying at least a certain amount of currency or foreign equivalent.
Where compliance gets difficult is when cash reporting is involved. People are required to report cash transactions exceeding $10,000 in connection with their trade or business. It is done by completing a Form 8300 where all parties to the transactions are identified. As you can probably guess, not a lot of people are fond of completing this form, particularly small, cash-based businesses. The transferor will be reluctant to give identifying information and could possibly lie. And the cash recipients will not want to force their customers to fill out this form or risk losing them. Finally, there are those people who are genuinely not familiar with this rule.
There have been occasional reports of the IRS and state tax agencies cracking down on cash transactions in the underground economy. For example, in 2014, the Treasury Department and the Immigrations and Customs Enforcement raided the Los Angeles Fashion District resulting in the arrest of nine people and mandating strict cash-related reporting requirements for businesses in the area. But it is likely that most people will be discreet with their cash transactions by not putting themselves in situations where they will be required to complete the Form 8300.
So would a reporting requirement affect cryptocurrency transactions? If so, how? There have been attempts to regulate reporting of cryptocurrency transactions in the past. The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed lowering the reporting threshold from $3,000 to $250 for any bank transaction that begins or ends in the United States. The proposal cited convertible virtual currency transactions as a reason for the change. FinCEN also proposed requiring banks and money service businesses to keep records of customers that engage in transactions involving virtual currencies.
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Exchanges that facilitate cryptocurrency transactions will be the biggest targets for any reporting rules, and the largest mainstream exchanges will likely follow it. Then that raises the question as to whether its customers will continue to use these exchanges or move their wallets to lesser-known exchanges that may not report their transactions? That no one knows for certain but some crypto holders and their advisors will be keeping their ears on whether the government can trace crypto transactions and base their decisions accordingly.
The Treasury Department report stated that cryptocurrency transactions are an IRS enforcement priority. But at this time, the IRS seems to be searching for those who can crack the crypto code. Just how hard is it? The people who hacked the Colonial Pipeline got their ransom money through cryptocurrencies which indicates how confident they are about its anonymity. Despite this, the IRS is seeking information on available technology and expertise on exploiting crypto wallets acknowledging that “the process of decrypting the hardware devices to gain access to the wallets [has] been challenging.” While this suggests that the IRS doesn’t yet have the means to access the wallets directly, it has other means of getting the information, usually through third-party investigations and issuing summonses to exchanges.
The government is stating (again) that it is taking steps to increase tax compliance on virtual currency transactions and propose a reporting requirement on large crypto transactions. Most people holding crypto are doing it to buy Lambos with Elon Musk and reluctantly know that paying taxes is part of the game. These people will comply so long as the guidance is clear. But these reporting requirements can be skirted and some exchanges may not do it at all. Tax agencies will have to figure out a way to crack the crypto wallet in order to identify those working in the shadows.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.