The IRS could be doing a better job of cracking down on tax noncompliance by users of virtual currency or digital assets, according to a new report. 

The report, released by the Treasury Inspector General for Tax Administration (TIGTA), acknowledged the IRS established "Operation Hidden Treasure" to identify taxpayers who omit digital assets, such as cryptocurrency, from their tax returns. However, the operation has been limited to the acquisition of tools and training, instead of pursuing taxpayers. The project's charter didn't include any specific enforcement goals, in terms of either criminal investigation or civil examination results, or statements identifying what it tried to achieve. 

The anonymity of virtual currency and the fact that crypto trading platforms don't consistently give reports to the IRS on virtual currency transactions complicates enforcement efforts, TIGTA noted. 

"The tax enforcement of virtual currency transactions is a challenge for the IRS because it does not have a clear window into taxpayers' virtual currency investments or transactions because their names generally are not directly attached," said the report. "Further, the IRS does not consistently get reports from trading platforms on virtual currency transactions." 

The number of taxpayers who use crypto as a payment method is growing. Between April 2020 and July 2023, the number of virtual currencies increased 420%. Because the IRS regards virtual currency as property, whenever a taxpayer uses crypto as a medium of exchange, that potentially creates taxable consequences.  

"Making payments with virtual currency has emboldened taxpayers to move money offshore, purchase illegal goods and services, and carry out other nefarious activities," said the report. "Users may feel there is the possibility of avoiding tax reporting obligations." 

The IRS's Criminal Investigation division has taken advantage of analytics tools to address virtual currency noncompliance, the report noted. From fiscal years 2018 to 2023, IRS CI investigated 390 cases involving virtual currency or digital assets, with 224 of those cases recommended for prosecution. 

On the civil side, the IRS's civil examination enforcement efforts that focus on digital assets such as crypto are "mostly indirect and negligible," according to TIGTA. Form 1040 does include a question about digital assets, but the publicly released version of the report is partially redacted, so it's unclear how this information from this question is used. 

The Infrastructure Investment and Jobs Act of 2021 requires brokers to file an information return listing any digital assets transactions during the year, so the IRS created a new information form, Form 1099-DA, to report the info needed to calculate gains or losses on such transactions. But while the law is supposed to take effect for transactions after Jan. 1, 2023, the proposed regulations are effective for transactions after Jan. 1, 2025, for gross proceeds reporting and Jan. 1, 2026, for basis reporting. The proposed two-year implementation delay will probably hamper efforts to regulate the crypto industry and result in lost tax revenue. 

TIGTA recommended the IRS develop a compliance plan that includes the use of Form 1099-DA data, case identification and case selection of digital asset cases. Other recommendations were mostly redacted. 

"The IRS agrees that digital asset compliance enforcement can be improved," wrote IRS chief tax compliance officer Heather Maloy in response to the report. "IRS compliance efforts are still recovering from years of underfunding. The multi-year funding provided by [the Inflation Reduction Act] enables us to hire more enforcement personnel as well as invest in data analytics and technology solutions to support compliance efforts. We will use enhanced data, analytics and technology tools to select compliance cases based on highest risk of noncompliance."