IRS inspector general says that crypto exchanges need more clarity on tax reporting

After conducting an audit of several virtual currency exchange examinations, the Internal Revenue Service (IRS) said it’s working with the Treasury Department to develop guidance on third-party reporting for transactions that involve cryptocurrency.

A report from the Treasury Inspector General for Tax Administration (TIGTA) indicates that crypto exchanges are interpreting existing guidance inconsistently from one another — and there soon may be clarity on whether they need to issue two more forms to their users.

The report — entitled “The Internal Revenue Service Can Improve Taxpayer Compliance for Virtual Currency Transactions” — recommends the IRS require all crypto exchanges file Form 1099-B, through which brokers report transactions on behalf of customers. The IG report, issued in late September, also notes that some exchanges with qualities of third-party settlement organizations (TPSOs) are required to report 1099-Ks, but not all of them currently fall under this umbrella. 

In response, TIGTA said the Deputy Commissioner for Services and Enforcement should issue guidance clarifying reporting standards for virtual currency transactions. The IRS agreed, contending that it’s currently working with the Treasury on developing that guidance.

The report reflects the internal process playing out within the U.S. tax authority. The IRS has made no secret that it wants to boost reporting rates among taxpayers and sniff out those trying to avoid scrutiny. 

The focus on crypto exchanges adds a new — though perhaps unsurprising — level of understanding of how the IRS is tackling its acknowledge crypto problems. 

TIGTA’s report argues virtual currency exchanges may be considered since they are often central entities that settle payments in a third-party payment network. This means they’re expected to fill out Form 1099-K, which details payment card and third-party network transactions. TPSOs fill out this form when gross payments reach $20,000 and transactions exceed 200 in a year.  

However, TIGTA found that there’s disagreement in the industry, resulting in a reporting gap.

The agency audited a number of exchange cases closed by Bank Secrecy Act (BSA) Program examiners, and found the exchanges took “inconsistent positions from one another on information reporting requirements.” Of nine reviewed cases, only four exchanges issued 1099-Ks in the years 2015 to 2018. 

According to the report, IRS officials said that’s because current rules are unclear as to whether crypto exchanged for fiat is considered “goods or services” rather than payment card transactions.

Additionally, in a second examination of seven exchanges by BSA Program officials, only three exchanges seemed to qualify as TPSOs.

In addition to the 1099-K question, exchanges lack clarity on whether they should report customer trading activity on Form 1099-B, which has brokers report transactions on behalf of customers. As of now, the Government Accountability Office has stated that the IRS doesn’t have an official stance on crypto exchanges and the 1099-B, but the report pointed out that some legal commentators believe it is already required, and TIGTA certainly thinks it is since it recommended the IRS require exchanges to file the form.

However, the same nine exchanges reviewed in the 1099-K audit mostly didn’t file them. Only one has issued 1099-Bs to customers from 2015 to 2018, with those figures growing each year from 103,414 in 2015 to 642,402 in 2018. 

The IRS has been extending its watch to cryptocurrency increasingly in recent months, attempting to add new ways of monitoring its use in the U.S. and clarifying existing guidance. The report follows a move by the IRS to ask taxpayers if they bought or sold any virtual currency on their 1040 Forms, an approach which also sought to mitigate the inconsistency in 1099-K issuance by helping the agency discern who is and isn’t holding crypto. 

Weeks earlier, a memo from the IRS indicated that cryptocurrency earned via microtasks is considered taxable income. In late August, the agency sent a second wave of letters warning crypto holders about their taxes — this followed a mass mailing from the previous year. 

The report itself was ordered as part of research into the Tax Gap — or the difference between what the IRS calculates it’s owed and what it’s been paid, — which it has estimated to be in the hundreds of billions of dollars for previous years.

Part of this problem boils down to information reporting by third parties, according to past Tax Gap studies. Questions around crypto reporting have made it harder to identify crypto holders, which the IRS is looking to clear up in the long term.

“The IRS cannot easily identify taxpayers with virtual currency transactions because of the lack of third-party information reporting that specifically identifies virtual currency transactions,” the report said, explaining:

“An information reporting regime that requires all virtual currency exchanges to report all virtual currency transactions to the IRS would benefit tax compliance by closing the information gap with respect to virtual currencies.”