Cryptocurrency Transfers and Data Collection

Cryptocurrency Transfers and Data Collection

August 25, 2021
Cryptocurrency Transfers and Data Collection
Overview
Internal Revenue Service
The extent to which the government should collect data on
The IRS collects data on crypto transactions in its role as
and require reporting of cryptocurrency (“crypto”) transfers
the administrator of the Internal Revenue Code. The IRS
has been the focus of recent policy discussions. Both the
has clarified, via Notice 2014-21 and an FAQ on virtual
Biden Administration’s FY2022 budget proposal and H.R.
currency transactions, that taxpayers are required for tax
3684, as amended and passed by the Senate on August 10,
purposes to treat crypto transactions in the same manner as
2021, would enhance and expand tax information reporting
transactions involving other mediums of value (e.g., cash,
for certain crypto transfers.
checks, stocks). For example, crypto transactions are
subject to the tax code’s capital gains and losses rules.
Requiring more data collection on crypto transfers presents
Similarly, federal income and employment tax rules apply
policymakers with a potential trade-off. On the one hand,
when crypto is used by a business to compensate an
enhanced data collection and reporting could lead to
individual for service provided.
increased tax revenue and lower levels of illicit financial
activity. On the other hand, enhanced data collection could
Crypto transactions are also generally subject to the same
lead some crypto market participants to move their
information reporting requirements as non-crypto
operations offshore to avoid government oversight, which
transactions. One exception appears to be the federal law
may negatively impact a burgeoning sector of the U.S.
requiring businesses to report transactions exceeding
economy.
$10,000 in cash to the IRS using Form 8300. IRS
Commissioner Charles Rettig stated at a June 8, 2021,
This In Focus summarizes current data reporting
Senate Committee on Finance hearing that he believes
requirements for certain crypto transfers, reviews recent
congressional authority is needed to apply the cash
policy proposals, and presents selected policy
transaction reporting requirements to crypto currency.
considerations.
In general, the data collected by the IRS primarily come
Cryptocurrency Transfer Practices
from voluntary reporting on annual tax returns and third-
Crypto transactions are typically carried out over a crypto
party information returns, as well as from summons and
exchange, which is a type of financial institution that
audits. IRS data, however, are far from complete, especialy
facilitates the trading, buying, and selling of various crypto
with respect to cryptocurrency. This reflects the intent of
assets such as Bitcoin, Ethereum, and Litecoin. Several
most cryptocurrencies “to stay off the radar screen,” as
crypto exchanges, such as Binance and Coinbase, are
Rettig stated at the hearing referenced previously.
licensed and regulated at the state level as money
Incomplete voluntary reporting of crypto transactions
transmitters, a type of financial company classification that
contributes to the tax gap, or the difference between the
includes other firms such as Western Union, MoneyGram,
aggregate amount of taxes legally owed and the aggregate
and PayPal. Some banking institutions known as custody
amount of taxes collected.
banks also provide crypto transfer services. (In addition, if
exchanges transact digital asset securities, they are subject
Financial Crimes Enforcement Network
to securities law, which is outside of the scope of this In
The federal agency responsible for implementing
Focus.)
regulations for money transmitters and provisions of the
BSA is the U.S. Treasury’s Financial Crimes Enforcement
Money transmitters generally carry out three business
Network (FinCEN). In 2013, FinCEN issued interpretative
functions: (1) receiving and sending money on behalf of
guidance for virtual currency exchanges, stating that an
consumers; (2) providing products that receive, store, or
“administrator or exchanger that (1) accepts and transmits a
send money for customers; and (3) exchanging currencies.
convertible virtual currency or (2) buys or sells convertible
Unlike banks, money transmitters do not accept deposits or
virtual currency for any reason is a money transmitter under
make loans but instead provide alternative mechanisms for
FinCEN’s regulation.” This guidance effectively brings
people to transfer money.
crypto exchanges under the same reporting regime as other
money transmitters.
Current Data Collection
Current federal data collection efforts on crypto transfers
Money transmitters are required to register with FinCEN
stem from two sources: the need for additional data so the
within 180 days of being established, and these registrations
Internal Revenue Service (IRS) can administer existing
are supposed to be renewed every two years. Money
federal tax law and anti-money laundering (AML) policies
transmitters must maintain financial records and conduct
that implement provisions of the Bank Secrecy Act (BSA;
customer identification procedures for certain transactions,
P.L. 91-508)—the primary U.S. AML law.
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Cryptocurrency Transfers and Data Col ection
and they must obtain and verify customer identity and
requirements, which they cannot satisfy due to the
record information for transfers of more than $3,000.
pseudonymous nature of crypto.
In addition, money transmitters must file currency
Another question concerns the appropriate balance between
transaction reports for transactions of $10,000 or more in a
government data collection and the rights of individuals.
day. They must also file suspicious activities reports
Data collection and reporting may assist the IRS and
(SARs) for dubious transactions of generally more than
FinCEN in fulfilling their statutory obligations, but it also
$2,000, which the remittance provider “knows, suspects, or
subjects individuals and businesses to greater government
has reason to suspect involves funds from illegal activity or
scrutiny and places an administrative burden on those
is designed to conceal their origin, is designed to evade
required to make reports . However, a certain amount of
BSA obligations, or has no apparent business or law
required reporting may enable individuals to more easily
purpose.” Money transmitters are prohibited from
comply with the law. For example, brokers are currently
disclosing to an individual involved with a transaction that
required to send individual investors a copy of any Form
a SAR has been filed. Further, the money transmitter and its
1099-B filed with the IRS. Form 1099-B contains important
employees are shielded from civil liability for any SAR
information taxpayers need to pay the appropriate tax on
filed.
transactions involving stock, bond, and other financial
securities.
Selected Policy Proposals
The President’s FY2022 budget proposes requiring crypto
Tax Gap
exchanges and custodians to file information returns with
The JCT’s estimates of H.R. 3684 suggest that requiring
the IRS that report the amount flowing into and out of
information returns on crypto transactions would reduce the
customer accounts with gross flows above $600. The
tax gap. The latest IRS estimates suggest that the gross tax
Administration’s proposal includes a separate reporting
gap costs the federal government $441 billion in lost tax
requirement for inter-broker crypto transfers and would
revenue per year. Late payments and enforcement actions
require businesses that accept crypto to report crypto
reduce this gap to $381 billion. One of the main drivers of
transactions exceeding $10,000 in value to the IRS.
the tax gap—whether from honest mistakes or purposeful
tax evasion—is understating tax liability. Income tax
The Administration also proposes expanding the
liability is understated as a result of taxpayers
information reporting requirements for brokers, including
underreporting their income and/or claiming more in tax
crypto exchanges and wallet providers, to include
benefits than they are eligible for.
information on U.S. and certain foreign account owners.
The Administration states this would allow for automatic
The latest IRS tax gap estimates generally do not reflect the
information sharing with foreign tax jurisdictions in
impact crypto is having on tax collections, as that market
exchange for information on U.S. taxpayers transacting in
was rather small during the period examined (2011-2013).
crypto outside the United States.
In an April 13, 2021, Senate Committee on Finance hearing
Commission Rettig raised the possibility that the tax gap
H.R. 3684, as passed by the Senate on August 10, 2021,
may now be closer to $1 trillion per year once the rise in
would require a party facilitating the transfer of crypto to
popularity of crypto, foreign source income, taxable illegal
file an information return as a broker with the IRS. The
income, and more recent estimates regarding high-income
Senate-passed version of H.R. 3684 would also require a
taxpayers are accounted for. Some have questioned the
business that receives crypto worth more than $10,000 in a
accuracy of this estimate. Although enhanced reporting
single transaction to report the transaction to the IRS. The
requirements may help to close the tax gap, some
Joint Committee on Taxation (JCT) estimates that these
underreporting of income generated from crypto
information reporting requirements would raise $28 billion
transactions will likely still continue as some crypto
over 10 years.
transactions are intended to elude authorities.
Selected Policy Considerations
Illicit Financial Activity
Reporting requirements raise a number of general policy
FinCEN’s data reporting regulations implement AML laws.
questions. One is the question of who should be responsible
The extent to which applying them to crypto can effectively
for the reporting. For example, brokers of transactions are
limit illicit financial activity, without stifling a potentially
responsible for reporting transaction data; however, crypto
beneficial financial tool, is an open question. Crypto can be
participants follow a range of business models that do not
used across jurisdictions with relative ease, and many
conceptually align with the current financial regulatory or
crypto users value its relative cash-like anonymity
tax code definitions of broker. This is evidenced by the rise
compared to traditional electronic money transfers. Thus,
of decentralized financial institutions, which allow peer-to-
enhancing reporting requirements on crypto transactions
peer transactions to occur without formal brokers.
may incentivize crypto customers to transact outside of the
United States. In addition, to the extent reporting
To that end, some industry stakeholders and policymakers
obligations are perceived as creating a “paper trail,” some
have expressed concern that the language regarding brokers
legitimate consumers who would otherwise use crypto may
in the Senate-passed version of H.R. 3684 is too broad and
avoid it. Policymakers face a tradeoff in this industry
could subject parties that would otherwise not be
between providing the necessary tools to ensure AML
considered brokers or middlemen (e.g., crypto software
compliance and driving activities out of the U.S. market.
developers, miners, blockchain validators) to reporting
Mark P. Keightley, Specialist in Economics
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Cryptocurrency Transfers and Data Col ection

IF11910
Andrew P. Scott, Analyst in Financial Economics

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