Cryptocurrency overall is extremely volatile. Recently, new revelations about the IRS’s misuse of crypto assets it has seized have thrown a whole new wrench into the landscape. A recent TIGTA report has exposed significant mismanagement and misaccounting by the IRS in their oversight of seized digital assets. That fact alone casts an enormous shadow on the agency’s legitimacy given the current race-paced development in the crypto world. This blog post walks through the most important findings of this report. It looks at what the IRS’s failures mean for taxpayers and what the IRS is doing to rectify these deeply concerning lapses.

The Case of the Missing Bitcoin: An $8 Billion Blunder?

The TIGTA report underscores some extremely troubling failures in the IRS’s handling of crypto assets that it has seized. One of the most extreme illustrations of this is James Zhong’s prosecution. He allegedly fraudulently acquired Bitcoin from the Silk Road underground marketplace.

When the Bitcoin was seized by the U.S. government on November 9, 2021, that roughly translated to about $3.36 billion. Further, Zhong voluntarily agreed to forfeit an additional 1,004.15 Bitcoin. On previous occasions, he donated 825.39 BTC and 35.45 BTC. Now, the combined value of the Bitcoin seized and surrendered was over $3.3 billion at time of seizure. The IRS Criminal Investigation (IRS-CI) found shocking failures in their management of these digital assets. They significantly undervalued their seized Bitcoin holdings due to basic miscalculations. Even more shockingly, they misreported the location of roughly 43% of all seized crypto assets as well.

These errors are unacceptable and raise troubling questions. This raises doubts about the IRS’s capacity to precisely maintain and adjudicate the enormous quantities of cryptocurrency it captures through its criminal probes. If the agency cannot even track where the assets are, it has a big problem on its hands. How can it protect them and make sure they’re being accurately counted? This complete absence of oversight opens the door to losses, misappropriation, and mismanagement of funds, and even creates the potential for fraud.

Taxpayer Troubles: Common Crypto Tax Mistakes to Avoid

The IRS’s struggle extends beyond its own internal challenges. Taxpayers themselves are still navigating the complexities of crypto taxation. Without some clear guidelines, you’re bound to make some mistakes by accident. These errors are costly, resulting in audits and penalties, given the always evolving regulatory environment. Here are some of the most common mistakes to avoid:

  • Not Reporting DeFi Transactions: Decentralized Finance (DeFi) is a rapidly growing area of the crypto space, but many taxpayers are unaware that these transactions are taxable events.
  • Misreporting Crypto-to-Crypto Trades: Each time you trade one cryptocurrency for another, it's considered a taxable event, and failing to report these trades accurately can lead to problems.
  • Failing to Track Cost Basis Correctly: Keeping accurate records of your cost basis (the original price you paid for your crypto) is essential for calculating capital gains or losses.
  • Misreporting NFT Collectibles: Non-fungible tokens (NFTs) are unique digital assets that can be subject to different tax rates, particularly if they are considered collectibles.
  • Overlooking NFT Taxation: Many taxpayers mistakenly believe that NFTs are not taxable, but this is not the case.

To avoid falling victim to these complexities, taxpayers must be prepared to do their homework, maintain detailed documentation, and consult with a tax professional when appropriate. One of the core tenets of KnowingCoin.com is owning your own chain, and that definitely extends to being aware of your tax game.

A Timeline of Guidance: IRS Attempts to Keep Up

Here’s a timeline of their attempts to provide guidance:

  • 2014: Notice 2014-21 provided initial guidance on the tax treatment of transactions using convertible virtual currencies.
  • 2019: Revenue Ruling 2019-24 addressed the tax implications of a hard fork.
  • 2020: FinCEN Notice 2020-2 outlined Report of Foreign Bank and Financial Accounts (FBAR) reporting requirements related to virtual currency.
  • 2023:
    • Revenue Ruling 2023-14 clarified the taxability of staking income.
    • Notice 2023-27 addressed the treatment of certain NFTs as collectibles.
    • Notice 2023-34 modified the background section of Notice 2014-21.
  • 2024:
    • Notice 2024-56 provided transitional relief for information reporting and backup withholding on digital assets by brokers.
    • Notice 2024-57 offered broker reporting and penalty relief for certain digital asset transactions.
    • Revenue Procedure 2024-28 offered guidance to allocate basis in digital assets to wallets or accounts as of January 1, 2025.
    • Final Regulations were issued regarding gross proceeds and basis reporting by brokers and determination of amount realized and basis for digital asset transactions.

The Path Forward: Regulation and Law Enforcement in the Crypto Age

The TIGTA report paints an ominous picture of crypto challenges. Even the most sophisticated taxpayers can run afoul of highly complicated regulations, highlighting the need for more explicit guidelines and better enforcement by the law. Several potential developments could shape the future of crypto regulation:

  • Clearer Regulatory Framework: The lack of clear regulations in the U.S. may lead to increased efforts to establish a comprehensive framework, potentially including stricter rules and guidelines for crypto market participants.
  • Increased Oversight: Regulatory bodies, such as the FDIC and SEC, may increase oversight and enforcement actions against crypto platforms and market participants, particularly in areas like anti-money laundering (AML) and know-your-customer (KYC) compliance.
  • State-Level Regulations: The varying approaches to crypto regulation across U.S. states may lead to a patchwork of different rules and guidelines, potentially creating challenges for national and international crypto companies.
  • International Cooperation: The growing global interest in crypto regulation may lead to increased international cooperation and coordination on regulatory approaches, potentially resulting in more consistent and effective regulations.
  • Investor Protection: Future regulations may focus on enhancing investor protection, such as improving disclosure requirements and preventing market manipulation.

Together, these developments have the potential to usher in historic changes for the crypto industry. Among other things, they can result in higher costs of compliance, heightened oversight of crypto firms, and more robust investor safeguards. The crypt landscape is always changing. It is imperative that regulators and market participants continue to evolve and work together to establish an equitable, transparent, and secure marketplace. At KnowingCoin.com, our mission is to arm you with the insights and technology you need to thrive in this new frontier. Our ultimate mission is to see you own your chain and slay the day!