Operation Hidden Treasure & Cryptocurrency Updates

Operation Hidden Treasure & Cryptocurrency Updates

Authored by: Gregory M. Ward, CPA, Haynie & Company Tax Manager

Operation Hidden Treasure & Cryptocurrency Updates

The IRS has taken major additional steps in the last few months related to virtual currency enforcement. Most of its work in 2020 focused on identifying the worst crypto tax evaders and encouraging compliance from exchanges. The Service outlined its goals for the immediate future and issued warnings to other non-compliant taxpayers. In early March, the announcement of Operation Hidden Treasure showed this initiative may escalate quicker than expected.

Operation Hidden Treasure is a joint criminal/civil operation the IRS launched to identify crypto tax evasion with more sophistication. Traditional bank account sweeps and fund tracing methods used to identify unreported income are not available here. Instead, they brought in experts on blockchain technology and virtual currency exchanges. These individuals will help identify recurring transaction patterns or structuring that is indicative of money laundering or other crimes. Rather than relying on crypto brokers to identify specific users, the IRS is “de-anonymizing” virtual wallets independently through transaction analysis.

Penalties & Criminal Charges

The leadership of this new operation also provides some much-needed insight into the penalties associated with these infractions. With both the civil fraud office and criminal investigation units involved, IRS directors have signaled that max penalties could include both criminal charges and the 75% civil fraud understatement penalty. There are still no indications of any voluntary disclosure programs or mitigated penalty options. This is in line with prior guidance and unwavering language regarding their new approach to the virtual currency area.

May 2021 Update

In early May, the IRS confirmed it has the authority to seize cryptocurrency assets and sell them to satisfy liabilities. The Service had not vocalized this position, likely due to the fuzzy definition of currencies as “property” in prior contexts. This announcement shows growing federal confidence in crypto classification. It also demonstrates a comfort level with seizure and liquidation in markets that are not as inherently understandable as securities markets.

More recently, in mid-May, the Treasury Department and President Biden announced they will require all exchanges to report any transactions over the $10,000 threshold. This requirement already applies to commercial banking activity. This will allow Operation Hidden Treasure to focus on criminal transactions designed to fall just under this limit. The announcement came just weeks after an additional “John Doe” summons to identify individuals with large transactions on the widely used Kraken exchange. It is also worth noting that SEC Chairman Gary Gensler has been vocal about the need for additional oversight and reporting requirements in the crypto sphere. This mounting federal pressure, combined with the agendas of several elected Congressional representatives, seems to indicate that we will see more guidelines soon.

TaxBit Audits

Beyond these reforms, the IRS announced it will contract with TaxBit to assist with individual tax return audits. TaxBit is a company that is already renowned for its sophisticated approach to transaction analysis and crypto gain reporting. The IRS will theoretically support any notice of deficiency sent out to trigger an examination with an accompanying TaxBit transaction summary to validate any proposed tax calculation changes. Experts had been curious as to how the IRS would handle this complex task related to penalty determination. This partnership shows they are willing to team up with industry leaders to overcome the challenge.

Taxpayer Reactions

On the other side, individual taxpayers have initiated tax court cases challenging various forms of virtual currency taxation. One taxpayer argued that the creation of coins is not a taxable event under existing tax law, despite IRS guidance. Others have argued that the use of virtual currency as a payment medium should not trigger gain recognition, which conflicts with IRS treatment of capital asset exchanges. Outside of technical financial arguments, another taxpayer contended that the IRS violated constitutional privacy rights with its data gathering. None of these cases have yielded favorable taxpayer results yet, but it will take years for various jurisdictions to resolve all of them and establish precedents.

Virtual currency stakeholders have shown a mixed reception to these changes. Some welcome the presence of federal regulators to help root out criminal participants and normalize income reporting. Many investors are concerned that the additional scrutiny will dampen growth, especially in the alternative coin market. Bitcoin, which had seen prices above $60,000 earlier this year, has lost nearly 50% of its value in a month. While other factors play a role in that decline, some have pointed to regulation as a negative catalyst. Only time will tell the extent of federal government entanglement and how that impacts investor appetite.

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