Tax preparers react to increased IRS crypto enforcement

The IRS is increasing its scrutiny of cryptocurrency investments and the tax treatment of these assets.

For example, the crypto transaction question has become longer on the next 1040 federal tax return, and the US government has recently been given special authority to question crypto exchanges about certain transactions and investors.

Earlier this year, the Biden administration issued an order requiring various agencies to produce reports this fall related to cryptocurrency regulation.

There is also a building sentiment for potential changes in tax laws to address concerns about cryptocurrencies. “In 2014, the IRS formally recognized that virtual currencies like bitcoin … should be treated as property more akin to a commodity than a security for tax purposes,” said Mark Connors, head of research at 3iQ in New York. “Since then, the IRS continues to enforce tax laws on US citizens who engage in the buying and selling of crypto-assets.”

Recently, for example, a U.S. District Court judge in California authorized the IRS to seek information from a Los Angeles-based cryptocurrency prime dealer about U.S. taxpayers who made at least the equivalent of $20,000 in crypto transactions between 2016 and 2021. The goal: hunting tax cheats. The IRS has also promised to investigate crypto-involved tax fraud as part of the new enforcement initiative following a bump in funding from the Inflation Reduction Act.

The IRS isn’t the only federal agency tightening crypto enforcement. In early 2022, BlockFi Lending LLC agreed to pay a $50 million federal fine as well as $50 million in fines to 32 states after being charged by the Securities and Exchange Commission with failing to register the offerings and sales of its crypto-lending product.

For federal tax purposes, the IRS says virtual currency is treated as property, with general tax principles that apply to property also applying to transactions using virtual currency. The IRS does not treat virtual currency as currency that could generate foreign exchange gain or loss for US federal income tax purposes.


“It is clear that the United States and other jurisdictions recognize the benefits of digital assets as well as the need to regulate both to protect the consumer and limit abuse,” Connors said. “As more US government agencies explore the benefits and risks of cryptoassets, including the immutability of blockchain activities, we expect enforcement to continue to increase.”

Especially as crypto technology gets involved. The advancement of blockchain analytics tools and their integrations within crypto exchanges and federal agencies is an important recent development in crypto tax enforcement, said Connor Loewen, cryptocurrency analyst at 3iQ in Toronto. “Several private businesses are offering these tools and services,” Loewen said. “These businesses work with enforcement agencies and engage in white-labeling of blockchain-based addresses and produce risk profiles for those addresses. These firms have also worked with federal prosecutors as expert witnesses.”

Although cryptoasset transactions may be pseudonymous, venues that allow trading of cryptoassets with fiat currency regularly cooperate with government bodies, including the IRS, and use KYC/AML monitoring services.

“If a pseudonymous wallet were to send crypto to an exchange account that wants to convert it back to fiat currency, the pseudonymous wallet now has an audit trail linking it to a KYC/AML-enabled account,” Connors said. “Since crypto exchanges in the US are regulated entities that enforce KYC/AML, they may disclose this client information to the IRS for possible prosecution if there is reason to believe that they have not recorded these gains or losses on their tax returns.”