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The IRS is Going After Crypto Tax Fraudsters. Here’s why that’s Not a Bad Thing

Cryptocurrency and the IRS have historically had an uneasy relationship. Questions about how the agency should tax crypto still linger, and as crypto has gained prominence, it’s become a more popular vehicle for tax fraud. In response, the IRS has turned to tax data analytics.

According to the IRS, tax evasion costs the United States $1 trillion every year. Since technologies like crypto are decentralized by design, they could account for a considerable portion of that fraud. Some crypto tax evasion may be mostly unintentional, too, as taxpayers may be unsure how the IRS taxes these assets.

As cryptocurrency fraud has become a larger concern for the IRS, tax data analytics has become an indispensable tool in addressing it. Here’s how.

The first sign of fraud is when the information in a tax return doesn’t line up. Tax data analytics engines can find these anomalies far faster than a person, comparing returns to previous years and known fraud cases. If the engine finds something unusual, it will flag it for further investigation.

After discovering something suspicious, these analytics tools can check to see if a taxpayer has unreported crypto transactions. While many blockchains are anonymous, people will eventually want to spend their crypto, often requiring them to convert it into fiat currency. Artificial intelligence algorithms can follow this trail of money to uncover an otherwise hidden crypto investment.

Finding and following these money trails requires analyzing a vast amount of data. For humans, that can be time-consuming, but not for AI.

How the IRS taxes crypto holdings or should tax it has been a subject of debate for some time. This has created some uncertainty around reporting crypto on tax forms, which can lead to mistakes. Consequently, some “tax evasion” cases may be entirely accidental, and data analytics can help reduce these instances too.

Over the past few years, the IRS has used data analytics to find how reporting mechanisms can improve. When they released some of these redesigned notices in 2017, the results were impressive. There was an 11% increase in payment compliance, a 31% increase in self-service tools, and an 8% reduction in penalties.

Using data analytics like this to edit reporting forms can make it easier to understand how taxpayers should report their crypto holdings. As these reporting mechanisms improve, accidental tax evasion will decrease.

The IRS’s tax data analytics programs, like many technological innovations, rose out of necessity. Tax forms and other relevant documents represent a massive amount of data, and the advent of cryptocurrency introduces more complexity to the system. Sifting through all of that data to uncover potential fraud is a monumental task.

To further complicate the IRS’s position, the agency’s workforce has diminished in the past few years. The agency now has fewer than 100,000 employees, thanks largely to budget cuts. Fewer employees trying to process more data increases the likelihood that the IRS could make a mistake.

Mistakes in fraud detection could lead to lengthy, complicated investigations into innocent taxpayers while actual fraudsters get away. Alternatively, taking the time to ensure everything is correct could delay tax returns, causing taxpayer stress. This is already a prominent issue, with the IRS having a backlog of 35 million returns in May.

Turning to data analytics instead of manual processes improves both accuracy and speed, mitigating these issues.

As the IRS increases its use of tax data analytics to address cryptocurrency, it will likely affect crypto investors. Most of the potential impacts are positive. For example, the increased accuracy could make things easier for compliant taxpayers by preventing false positives.

Catching and penalizing unscrupulous crypto investors like money launderers could also bring more legitimacy to crypto. Increased efficacy in addressing crypto tax fraud will help ensure compliant taxpayers account for a larger portion of overall crypto investors. This could encourage more organizations to accept crypto as a legitimate payment method.

One potential downside is that the increased accuracy of tax data analytics could mean crypto investors will have to pay more taxes. These tools equip the IRS to tax crypto more effectively, potentially leading to tighter regulations.

As cryptocurrencies become more popular, the IRS will pay more attention to them. With tools like tax data analytics, the IRS can now tackle crypto with greater accuracy and speed. This change will help eliminate fraud but could also open the door to more regulation.

How the IRS’s tax analytics programs will affect crypto remains largely uncertain. If early signs are any indication, though, this innovation could change crypto taxes for the better.