Digital Assets Transactions Subject to IRS Increased Enforcement Activities

On 4/5/23, the IRS published the Inflation Reduction Act Strategic Operating Plan where it states that the Agency will pursue enforcement for complex, high-risk and emerging issues; including digital assets transactions. IRS reports in its Operating Plan that digital asset transactions have high risk for non-compliance. Despite the IRS’s resource limitations, the Agency reports that it will prioritize resources to increase enforcement activities, including criminal investigation as appropriate;  as well as improve non-compliance detection and identify trends and risks of digital asset transaction.

IRS already took its first step to track digital assets transactions by changing Form 1040 in 2022

Form 1040 2022 changes the crypto terminology from “virtual currency” to “digital assets” which includes a broader category that includes cryptocurrencies, stablecoins, NFTs, as well as staking tokens, amongst others.  The purpose of the change in terminology could be interpreted as a “heads up” to taxpayers that the IRS is looking more closely as well as an intention to provide more clarity. That said, taxpayers ought to treat the expanded terminology or rewording that the IRS wants to know all about a taxpayer’s crypto dealings and if a taxpayer is uninformed – he or she will be an easy IRS audit target.  The 1040 2022 Instructions instruct all taxpayers to answer the digital asset 2022 question on Forms 1040 and 1040-SR as follows: “Do not leave this field blank. The question must be answered by all taxpayers, not just taxpayers who engaged in a transaction involving digital assets”.

Taxpayers ought to remember that the IRS 2022 1040 Instructions state that:  “You have a financial interest in a digital asset if you are the owner of record of a digital asset, or have an ownership stake in an account that holds one or more digital assets, including the rights and obligations to acquire a financial interest, or you own a wallet that holds digital assets.”

IRS compliance treatments for digital asset transactions highlighted in the Operating Plan are:

• Mobilize resources to focus on high-risk and emerging issues that have not received appropriate enforcement attention pertaining to digital assets.
• Improve, expedite, and scale detection of digital assets, including building stronger feedback processes from all parts of the IRS.
• Reinforce and expand the IRS’s strategic detection of issues and develop pathways for providing feedback.
• Establish processes to respond more rapidly to emerging issues and develop treatments that can be deployed quickly and integrated into enforcement efforts.
• Develop and deploy new digital tools and analytics capabilities to respond to and enforce tax laws.
• Explore and pilot enforcement treatments.
• Refine existing tools and processes, such as audits, to adapt to a changing landscape.
• Use improved analytics to identify patterns of noncompliance and apply the most appropriate treatment to each taxpayer situation.
• Hire, onboard and train the staff needed to achieve appropriate compliance coverage rates.
• Information Returns platform enhanced to support digital asset reporting in FY 2024.
• New analytics-enabled capabilities developed to support digital asset compliance in FY 2024.

Bottom line – the IRS continues to increase digital asset transaction scrutiny!

Having proper documentation of your digital assets will help in case of banking requirements and while filing taxes, at the same time protecting you against an IRS audit. Remember that changes in your holdings of digital assets must be reported even if you received or transferred digital assets for free, be it as a bona fide gift, or the result of a reward or award.

Are you properly accounting your Digital assets? ©