The IRS is overburdened. What does that mean for crypto taxpayers?

“The 2021 filing season was the quintessential definition of a perfect storm.”

That’s how the Internal Revenue Service opened its review of last year’s filing season, which it published in its Fiscal Year 2022 Objectives Report to Congress. The tax agency noted the extreme variables that led to a messy, overburdened year — mainly, the COVID-19 pandemic and the ensuing financial relief programs Congress tasked the agency with executing. 

The storm isn’t over. The IRS began accepting individual tax returns last week, and it is still facing a backlog of millions of unprocessed returns from previous years. 

Meanwhile, crypto is under the tax watchdog’s microscope. With mounting pressure from the Treasury, the IRS is hoping to increase tax compliance from crypto investors — despite continued pleas from such investors for more clarity from the agency on how to report complicated trading activity. 

Crypto tax experts say an overburdened IRS mostly means that the usual process will take longer — more hours to get through to a helpline, additional weeks to get a refund back, perhaps years before the agency looks at a crypto case closely enough to determine if an audit is necessary. 

Still, the IRS taking its time doesn’t mean the taxpayer should. Experts say the fact that the IRS is so overburdened is no reason not to file — and it seems like most crypto traders are finally seeming to understand that.

The backlog

The IRS starts each year at a deficit, working to catch up on previous years. But that deficit has more than doubled in the last year. 

The majority of tax filings are electronic, but there are still some who mail their reporting to the tax watchdog. Dealing with this physical mail represents about half of the IRS’s manual processing burden — the biggest drain on resources since it requires manpower to open and respond to the cases. 

At the end of last tax season, the IRS still had over 35 million individual and business tax cases that couldn’t be processed electronically. For context, the 2020 filing season drew about 10 million cases that needed manual processing, and there were 7.4 million in 2019. 

The backlog grew over 200% in the course of a year, and there are a number of reasons for this. The IRS itself pointed to a few in its review:

“The combination of pandemic-induced shutdowns, three rounds of economic impact payments, challenges with paper return filings, a backlog of over 35 million suspended 2020 returns, and the responsibilities of implementing new legislation resulted in a challenging 2021 filing season for the IRS and tens of millions of taxpayers — one that will continue to be analyzed for lessons learned for future filing seasons.”

The IRS is a workplace like any other, and like others it had to adjust its workflow to post-COVID working life. But, as Seth Wilks, Senior Director of SME and Government Relations at TaxBit, pointed out in a recent interview for an episode of The Scoop, the IRS has a waning workforce. Its ranks are traditionally older, meaning many are close to retirement. 

In addition to staffing shortages, the IRS is slow to update its technology and processes, and the bureaucracy of government doesn’t allow for the agency to pivot as quickly as a private business.

“The technology for the service is just all sort of antiquated,” said Wilks. 

The consequences for crypto

The major result of all this is that this year certain standard processes may take an extraordinarily long time to complete. 

Justin Woodward, co-founder and tax attorney at TaxBit, explained the current auditing process in a recent episode of The Scoop. The IRS uses electronic matching systems to compare a taxpayer’s reported income and trading activity to the form the exchange venue submits. Discrepancies result in an audit asking taxpayers to reconcile the differences. 

“The bigger the backlog gets, the further behind they get, so that doesn't necessarily mean that you're in the clear,” said Woodward. “If you filed your tax return and you didn't hear from the IRS for two years it may just take more time for the IRS to actually get to your case.”

Shehan Chandrasekera, head of tax strategy at CoinTracker, said the biggest effect of the backlog will likely be a considerable delay in refunds. Businesses counting on claimed losses for some degree of relief could end up waiting a lot longer than the usual six to eight weeks. It could be months before a refund materializes in the current situation, which could put new strain on firms.

To expedite the process, the IRS and tax firms are encouraging people to file early and electronically. If you mail in your returns, it will likely take the IRS some time to get to it.

Since the IRS isn’t opening its mail fast enough, it may mistakenly think you are evading your taxes, leading some to receive late notices or penalties when their filing is already sitting in the IRS’s unopened pile, said Dan Hannum, COO at Zenledger.

Finally, do not assume that since the IRS is so busy you can get away with neglecting to file.

Adding to the agency’s to-do list is the hotly-debated infrastructure bill, which President Biden signed into law in November. The law includes new provisions that will in some ways simplify the filing process for crypto firms and eventually translate to an easier filing season for taxpayers. But the provisions of the bill don’t take effect until next year, so this year crypto filers are still on their own. 

Figuring out how to clarify the provisions of the new law — specifically its controversial definition of what qualifies as a “broker,” and thus is required to report user information and transaction history to the IRS — is yet another task on the IRS’s growing plate. Still, tax experts say the lack of unified broker reporting this year is no excuse not to file, and there is enough information for crypto-holding taxpayers to adequately report activity, even if it’s a challenge. 

However, as Wilks pointed out, any use cases or quick questions an accountant or filer needs answered will likely require blocking out a day to sit on hold with the IRS. 

Despite these challenges, crypto taxpayers are taking their burden more seriously than ever, according to Hannum.

“We think that from a crypto perspective, we'll probably see the highest compliance rates this year that we've ever seen, and we think that that trend likely is going to continue to increase year over year for the next few years,” he said.