TAKEAWAYS

• The IRS has increased funding for collection and enforcement, with a stated focus on high income non-filers and digital assets (among other areas).
• The DOJ has also emphasized a focus on digital assets, and the Department and the IRS recently pursued their first criminal action against a taxpayer who did not accurately report cryptocurrency proceeds from otherwise legitimate transactions.
• Filing timely, correct and complete tax returns is more important than ever, especially for those in targeted categories.

The most recent data available from the Internal Revenue Service (IRS) shows that it processed more than 262.8 million tax forms in Fiscal Year 2022, collecting more than $4.9 trillion. To ensure that taxes owed are taxes collected, the IRS and the Department of Justice (DOJ) Tax Division maintain an active criminal and civil enforcement program. Collection and enforcement require budget; in 2022, the Inflation Reduction Act (IRA) authorized an additional $80 billion of IRS funding to strengthen tax collection and enforcement—particularly with respect to corporate taxes, high income non-filers and other specified priorities. In Fiscal Year 2024, the DOJ Tax Division sought an increased budget and increased attorney numbers to keep pace with IRS tax enforcement.

Despite the government’s heightened focus on criminal and civil tax enforcement, some individuals and companies still miss filing deadlines and hope to become tax compliant before the IRS comes knocking. This strategy is typically a bad idea. The IRS has always viewed noncompliance harshly, especially when an issue is not identified voluntarily and preemptively. The additional IRA funding earmarked for the pursuit of noncompliant taxpayers increases the likelihood that the IRS and DOJ will identify and pursue tax violations, especially by those taxpayers in targeted categories.

2024 IRS Priorities: High-Income Non-Filers, Partnerships and Corporate Jets
According to the IRS, key audit priorities for 2024 include high-income non-filers, partnerships and corporate jets. These priorities correlate to the Biden Administration’s policy goal of reducing the perceived gap between taxes paid and owed by wealthy individuals and businesses, while also reducing the audit burden on low-income taxpayers. With respect to non-filers, the IRS announced a “new effort” in February 2024 to focus audit resources on high-income taxpayers that have not filed federal income tax returns since 2017. This effort will begin with the IRS sending over 125,000 compliance letters, known as CP59 notices, to persons with no tax returns filed between 2017 through 2021. IRS data indicates that approximately 25,000 of those non-filers had over $1 million in annual income during the relevant tax years. More than 100,000 of the letter recipients had annual incomes between $400,000 and $1 million. The IRS began sending CP59 notices in February 2024, with approximately 20,000 to 40,000 letters projected to go out weekly. The IRS’s initial focus will be on filers in the highest income categories.

Taxpayers who receive a CP59 notice should take immediate action and consult a trusted tax professional who can help them promptly file the late returns and pay delinquent tax, interest and penalties. The failure-to-file penalty is 5% of the total amount owed, calculated monthly, or up to 25% of the tax bill. Failure to take action will lead to further notices, higher penalties and stronger enforcement measures, potentially including criminal prosecution.

The IRS can also file a “Substitute for Return” (SFR) for non-filers, i.e., a substitute tax return prepared by the IRS based on income reported to the agency. An SFR calculates the taxes, penalties and interest owed by the taxpayer—and might not credit the taxpayer for allowable deductions and exemptions. After the filing of an SFR, the IRS will send a CP3219N notice of deficiency (a 90-day letter) proposing a tax assessment. The taxpayer has 90 days to submit the past due tax return or file a petition in Tax Court. Should the taxpayer neglect to do either, the IRS will proceed with the tax assessment proposed under the SFR. A collection process is triggered if tax assessed under the SFR process remains unpaid, which can lead to a levy on wages or bank accounts; the filing of a federal tax lien; additional penalties; and/or criminal prosecution.

Digital Asset Reporting
Digital Asset noncompliance is another emerging trend in U.S. tax enforcement. The IRS has issued guidance regarding the tax consequences on the use of virtual currencies in IRS Notice 2014-21, which provides that virtual currencies that can be converted into traditional currency are property for tax purposes and subject to tax assessment. For years the IRS has warned taxpayers to report all cryptocurrency transactions accurately, promising increased enforcement in this area. Such warnings have also included a threat to pursue criminal charges for noncompliance, likening the non-reporting of digital assets to the non-reporting of foreign financial accounts, which has resulted in criminal prosecution.

Moving beyond mere warnings, the IRS more recently has pursued information requests directly with high-profile digital asset exchanges such as Coinbase and Kraken. These requests have come in the form of “John Doe” summonses, which direct an exchange to produce records identifying U.S. taxpayers who have used its services, along with other documents relating to their virtual currency transactions. These summons request information about the exchange’s customers involved in digital asset transactions above a certain size, including information about the transactions themselves. While subject to ongoing litigation both by the platforms themselves as well as an individual taxpayer, the IRS’s use of John Doe summons has mostly been allowed by the courts (though sometimes limited in scope).

In 2019, the IRS updated Form 1040 to require front-page disclosure of a taxpayer’s “virtual currency” activity. The disclosure required was initially limited, but the form was updated again in 2021 to cover “digital assets” rather than merely “virtual currencies.” This change in terminology suggested that the IRS meant to target a broader range of digital transactions. The 2021 changes also nullified the ability of a taxpayer to rely on the lack of willfulness as a defense to non-reporting.

The IRS Criminal Investigation (CI) division, tasked with the investigation of potential criminal tax violations along with the DOJ, announced in November 2022 that it had hundreds of crypto-related cases for which it expected to bring related charges. These early warnings gave taxpayers advance notice of pending enforcement and time to correct any misreporting before the DOJ and IRS CI took action.

Digital assets are also an enforcement priority for the DOJ. In 2022, the DOJ released The Role Of Law Enforcement In Detecting, Investigating, And Prosecuting Criminal Activity Related To Digital Assets pursuant to President Biden’s March 2022 Executive Order regarding responsible digital assets development. This DOJ report emphasized the manner in which digital assets are used to facilitate crimes, including criminal tax violations, and highlighted certain initiatives that the DOJ and other law enforcement agencies have established to detect, investigate and prosecute such crimes. On publishing this report, the DOJ also announced the creation of a national Digital Asset Coordinator Network (DACN), a network of over 150 designated federal prosecutors from U.S. Attorneys’ offices nationwide that serves as a centralized forum where DOJ prosecutors can receive training and guidance on the investigation and prosecution of digital assets crimes.

The IRS CI division in November 2022 publicly declared it had hundreds of crypto-related cases and that it expected to bring related charges. These early warnings were intended to give taxpayers advance notice of pending enforcement as well as time to correct any misreporting before action by the DOJ and IRS CI.

The first criminal indictment relating to the non-reporting of digital assets became public in February 2024. The taxpayer in this case was accused of exaggerating his cost basis in bitcoin and underreporting capital gains of about $4 million. He was also accused of dividing his bitcoin earnings into smaller deposit amounts to avoid law enforcement attention and of neglecting to report the capital gains from such transactions. Notably—and different from earlier digital assets-related tax cases—the taxpayer’s alleged violations were unrelated to other criminal activities, such as money laundering. The taxpayer had participated in genuine purchases and sales of digital assets but had failed to report those transactions correctly on his tax returns. These failures gave rise to criminal charges. Given the recent IRS and DOJ messaging, similar cases seem likely to follow.

Conclusion
The IRS and DOJ are aggressively investigating and prosecuting tax violations, especially violations by high-income non-filers and those involving digital assets. Taxpayers should ensure accurate reporting, which for digital assets is not always easy to do, due to the difficulty of recordkeeping and the 24/7 nature of the global marketplace. Taxpayers who have misreported or underreported should contact a qualified tax professional immediately, including an attorney, to become compliant as soon as is practicable.