When the Internal Revenue Service (IRS) signaled that it was getting serious about cryptocurrency, the agency wasn’t kidding. The IRS is now offering cash to anyone who can “reliably produce useful results on a variety of real-world CI cryptocurrency investigations involving Monero and/or Lightning.” That’s right: they are looking for code crackers.
The IRS has made no secret that it believes that taxpayers are not correctly reporting cryptocurrency transactions. An IRS dive into the data showed that for the 2013 through 2015 tax years, when IRS matched data collected from forms 8949, Sales and Other Dispositions of Capital Assets, which were filed electronically, they found that just 807 individuals reported a transaction using a property description likely related to bitcoin in 2013; in 2014, that number was only 893; and in 2015, the number fell to 802.
Cryptocurrency Compliance Efforts
A new cryptocurrency compliance measure for taxpayers was introduced in 2019 in the form of a checkbox on the top of Schedule 1, Additional Income and Adjustments to Income (Schedule 1 is used to report income or adjustments to income that can’t be entered directly on the front page of form 1040). And in 2020, the IRS noted that it will post a cryptocurrency question right on the front page of your Form 1040.
In 2019, the IRS also announced that it was sending letters to taxpayers who might have failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly. The names of these taxpayers were obtained through various ongoing IRS compliance efforts.
(For more on some of those efforts – like the Coinbase court saga – click here.)
Pilot IRS Cryptocurrency Tracing
Now, the IRS is offering what some are calling a “bounty” to those who can assist in tracing cryptocurrency transactions. Specifically, the IRS has created a pilot that will pay cash (up to $625,000) to anyone who can trace Monero or other anonymity-enhanced cryptocurrency, or Lightning or other Layer 2 off-chain cryptocurrency protocols.
You can read the official Request for Proposals (RFP) here (you can also find out more about the process).
The deadline for submissions is Wednesday, September 16, 2020, at 08:00 EDT. No late submissions will be accepted or considered or evaluated.
About Privacy Coins
The focus of the proposal is privacy coins. Privacy coins allow users more anonymity when using cryptocurrency. According to the IRS-CI, the use of privacy coins is becoming more popular not only by investors, but also by illicit actors. For example, according to the IRS-CI, in April 2020, a RaaS (Ransomware as a Service) group called Sodinokibi (a former affiliate with the GrandCrab RaaS group) stated that future ransom request payments will be in Monero (XMR) rather than Bitcoin (BTC) due to transaction privacy concerns.
Bitcoin has become increasingly common since it’s easy to use – even for relative crypto newbies. Bitcoin transactions are open ledger (blockchain): that means that the record-keeping system is “public” through a series or chain of blocks even though the exact identities of the participants (as well as their other details, like account balances) may remain private. This kind of open system encourages transparency but also means that, with some effort, hackers and others – like the authorities – can track down the players in a chain of transactions.
The result has been a push from some crypto-sectors to completely anonymize all pieces of the transaction. Enter privacy coins. Monero is considered the largest privacy coin on the market right now; the technology it uses extends privacy to senders, receivers, and transaction amounts. Other popular privacy coins include Cash (ZEC) and Dash.
IRS-CI Is Looking For Solutions
Now, IRS-CI is looking for solutions which provide “information and technical capabilities for CI Special Agents to trace transaction inputs and outputs to a specific user and differentiate them from mixins/multisig actors for Monero and/or Lightning Layer 2 cryptocurrency transactions with minimal involvement of external vendors” as well as “technology which, given information about specific parties and/or transactions in the Monero and/or Lightning networks, allows Special Agents to predict statistical likelihoods of other transaction inputs, outputs, metadata, and public identifiers with minimal involvement of external vendors.” In other words, they are looking to crack privacy coins.
If this sounds out of the ordinary, you’re not wrong. And the IRS acknowledges as much, stating, “For those who are familiar with traditional government procurements, Pilot IRS will appear substantively different from how the government normally buys technology. To be fair, it is… This type of approach is more often used in research and development environments, but there are existing regulations that allow federal agencies to buy commercial items in a manner similar with how the private sector would. Pilot IRS will aggressively pursue a streamlined and cost-effective approach to testing and deploying technology solutions that will have an immediate impact on the government’s mission.”
IRS-CI has noted an uptick in criminal syndicates using privacy coins. And authorities have to be able to keep up. An IRS-CI spokesperson stated that, “IRS-CI is responsible for investigating potential criminal violations of the U.S. Internal Revenue Code and related financial crimes. We are also a global leader in cyber-criminal investigations involving cryptocurrency and have played a lead or key role in the takedown of numerous major Darknet Marketplaces and other transnational criminal organizations facilitating identify theft, narcotics trafficking, money laundering, terrorist financing, sex trafficking, and child prostitution.”
As a result, he explained, “The IRS Cryptocurrency pilot was developed to create and promote innovation in response to ongoing challenges within IRS-CI in hopes of quickly testing, piloting and/or deploying solutions. Privacy coins continue to be a challenge to law enforcement due to their increased anonymity and specific technological enhancements. Currently, there are limited investigative resources for tracing transactions involving privacy cryptocurrency coins such as Monero, Layer 2 network protocol transactions such as Lightning Labs, or other off-chain transactions that provide privacy to illicit actors. The pilot will look to leverage the knowledge of public/private sector and academia to address these specific challenges.” Follow me on Twitter or LinkedIn. Check out my website or some of my other work here.
I cover tax and its impact on the lives of taxpayers and tax professionals. In addition to Forbes, you can find me at my own blog, Taxgirl.com, which has been consistently recognized by the ABA Journal as one of the top blogs written by lawyers. You can also subscribe to my newsletter – which features articles from the blog and Forbes – here. I am a member of the bars of Pennsylvania and New Jersey and licensed to practice in front of the U.S. Tax Court. I’m also permitted to engage in pro bono practice in my home state of North Carolina through Legal Aid of N.C.
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