Does the IRS Fear Bitcoin?

An op-ed in the New York Times theorizes that the IRS fears Bitcoin due to tax evasion. What actions could the IRS take to combat this?

The Internal Revenue Service (IRS) is one of the most feared federal agencies in the United States. They can garnish wages, levy fines, put liens on personal property, and even send you to jail for failing to pay the appropriate taxes. Which is why it’s interesting to see an op-ed in the New York Times say that the IRS is afraid of Bitcoin.

Does Anything Frighten the IRS?

The op-ed was written by Richard Holden and Anup Malani. Holden is a professor of economics at the University of South Wales while Malani is a law professor at the University of Chicago. While their op-ed headline says “Why the I.R.S. Fears Bitcoin,” what they actually argue is that the tax agency fears is the effect of cryptocurrency upon revenue collection.

A pretty significant amount of money goes untaxed each year in the US due to the underground economy that is currently cash-based. The Internal Revenue Service estimates that a whopping $500 billion in revenue is lost each year due to unreported wages.

What the Internal Revenue Service fears is that Bitcoin and other cryptocurrencies could become much more mainstream and used on a daily basis. Currently, it is somewhat of a hassle for people to exclusively use cash as one has to withdraw it, carry it on their person, and payments have to be made face-to-face. Cryptocurrency is much more flexible and easy, allowing for guaranteed payments to be sent or received anywhere in the world. Suddenly, the scope of the underground economy expands exponentially if Bitcoin becomes an everyday source of personal transactions.

The Tax Problem with Bitcoin

The Internal Revenue Service knows that a lot of people are currently not paying their taxes on Bitcoin, which they found out by examining the Coinbase accounts they gained access to. They found that only 0.2% of users reported Bitcoin gains or losses.

This tax evasion could be even worse if someone shuttles around their cryptocurrency through various addresses. The op-ed authors imagine a scenario where a person bought Bitcoin at $15,000, then transferred it to a second address when it hit $15,500. That Bitcoin is then sent to a third address (owned by the same user), and the coin eventually reaches a total value of $25,000. The user can then send the Bitcoin back to their original address and claim that they only made $500 (when they sent the Bitcoin to the second address). The user also tells the taxman that they just bought a Bitcoin for $25,000 from another user. Of course, the IRS is unaware that the second and third addresses are owned by the same person.

The above scenario is an intriguing one and would require multiple exchanges (ones that lay outside of the purview of the US) to work. Such a scenario and the purported anonymity that cryptocurrency provides is enough to give the taxman an upset stomach.

Ways to Clampdown on Bitcoin

The authors of the op-ed argue that the Internal Revenue Service has several options to combat their Bitcoin problem. One is to raise tax rates across the board to make up for the loss in revenue. This is definitely a non-starter as people will rise up in arms, and the current administration has no desire to commit political suicide over this idea.

Another method of dealing with Bitcoin is to ban all cryptocurrency outright. This is a possibility as any government does not like a system, especially economic, that lies outside of their control. However, I think such a scenario is unlikely as the possibility of taxing crypto is just too potent a lure to pass up. If the government can tax something, they will.

The last major way of handling Bitcoin discussed by the op-ed is to change the tax code so that taxes are collected when money is spent, not when it is earned. Basically, the current income tax system is replaced entirely by a consumption tax. To be honest, this is probably the best way to handle the problem of tax evasion as everybody has to spend money, whether it be for food, rent, entertainment, or transportation.

However, the likelihood of seeing a consumption tax replace the Gordian Knot of a tax code found in the US now is slim to none. The current tax system is designed for various special interests, all of whom have congressmen in their pocket.

Overall, the IRS does not fear cryptocurrency itself, but it does fear the effect that it can have upon the underground economy and tax evasion. The likely scenario that crypto enthusiasts in the US will see in the future is increased regulation and a removal of anonymity on exchanges. In the end, the taxman always gets his pound of flesh.

What do you think about the IRS and their issues with Bitcoin? What steps do you think they’ll take? Let us know in the comments below.

Images courtesy of Wikimedia Commons and Bitcoinist archives.

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