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The IRS Confirms Its “Great Eye” is Firmly Fixed on Cryptocurrency, Announcing “Operation Hidden Treasure” By EVAN DAVIS

In the Lord of the Rings saga, the antagonist is a disembodied entity called Sauron who was represented by a flame-filled “Great Eye.”  Sauron’s Great Eye had powerful vision when fixed upon his rivals, but even this powerful eye was unable to see unaided into the thoughts of humans.  Fans of the LOTR movies know that Sauron used a mighty orb called a Palantir to see where his Great Eye could not, forcing rivals to reveal their secrets.

What does that have to do with the IRS and cryptocurrency?  The IRS has to identify illegal non-filers and evaluate the veracity of hundreds of millions of tax returns by looking for inconsistencies on the face of the returns, comparing returns or the lack thereof to other filings such as W-2s and 1099s, and even evaluating the filed returns and non-filing against publicly available information.  Despite its desire to do so, the IRS can’t focus on everything at once, but when it does focus its attention on certain taxpayers or transactions, it can be bad news for those whom the IRS has selected for further investigation.

The IRS has been slowly turning its gaze toward cryptocurrency for the past five years, notably beginning with the 2016 Coinbase summons that was designed to identify thousands of non-filers and filers who had omitted substantial transactions in cryptocurrency.  Between 2016 and 2020, the IRS rolled out additional tools designed to sharpen its vision on cryptocurrency.  It contracted with ChainAnalysis[1] to harvest data from the Blockchain concerning unreported cryptocurrency transactions.  Bitcoin transactions occur in the public environment of the Blockchain.  They are only made confidential through the interaction with private keys, but the public aspects allow the IRS to piece together public and tax information to determine who conducted those transactions despite not knowing the private keys.  The IRS prioritized training its Revenue Agents on how to incorporate cryptocurrency into its audits, Revenue Officers on how to identify and levy cryptocurrency, and Special Agents on how to conduct criminal investigations of unreported cryptocurrency.  It updated tax forms, including the 1040, Voluntary Disclosure, and collection forms, to require reporting of crypto ownership and/or transactions.  Taking a page from Sauron’s book, the IRS also harnessed the aptly named Palantir[2] data analysis tool to identify cryptocurrency patterns and connections in data available to the IRS, allowing the IRS to identify worthwhile investigations as well as to advance investigations.  With each step, the IRS has increased data that could be harvested, sharpened its employees’ skills, and left fewer dark corners for crypto non-filers and non-reporters to hide.

Just as April 15, 2021 approaches, at a March 5, 2021 Federal Bar Association conference, the IRS’s director of the new Fraud Enforcement Office, former IRS CI Special Agent in Charge Damon Rowe, announced the agency’s latest focus on cryptocurrency, Operation Hidden Treasure.  Director Rowe, along with the IRS’s National Fraud Counsel Carolyn Schenck, described how the criminal side of the IRS is working in tandem with civil investigators to train agents and conduct parallel investigations of omitted crypto income.  In addition to investigating crypto omissions, Ms. Schenck noted these sophisticated tools permit the IRS to identify and seize crypto in civil and criminal cases.  The seizure of crypto appears to be quite rare today given the technological and practical challenges of obtaining the taxpayer’s required private key, but the IRS is fully aware that it can enlist courts to force the disclosure of private keys in most collection situations.  The fact that the IRS is paying for additional tools means the IRS is expecting a good return on investment in the form of crypto seizures.  With bitcoin prices skyrocketing, these assets are becoming more and more attractive for civil collection and criminal seizure.

What does the IRS want crypto-owning taxpayers and tax professionals to take away from Operation Hidden Treasure, which is backed by ChainAnalysis, stepped-up training, and Palantir?  The IRS’s Great Eye won’t turn away from crypto.  As Ms. Schenck said, “We see you.”

For additional information, see IRS’s ‘Operation Hidden Treasure’ Focusing on Crypto Fraud (bloombergtax.com)                   

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis has been a principal at Hochman Salkin Toscher Perez P.C. since November 2016.  He spent 11 years as an AUSA in the Office of the U.S. Attorney (C.D. Cal), spending three years in the Tax Division where he handed civil and criminal tax cases and eight years in the Major Frauds Section of the Criminal Division where he handled white-collar, tax, and other fraud cases through jury trial and appeal.  As an AUSA, he served as the Bankruptcy Fraud coordinator, Financial Institution Fraud coordinator, and Securities Fraud coordinator.  Among other awards as a prosecutor, he received an award from the CDCA Bankruptcy Judges for combatting Bankruptcy Fraud and the U.S. Attorney General awarded him the Distinguished Service Award (DOJ’s highest litigation award) for his work on the $16 Billion RMBS settlement with Bank of America.  Before becoming an AUSA, Mr. Davis was a civil trial attorney in the Department of Justice’s Tax Division in Washington, D.C. for nearly 8 years, the last three of which he was recognized with Outstanding Attorney awards.  He is a magna cum laude and Order of the Coif graduate of Cornell Law School and cum laude graduate of Colgate University.Mr. Davis represents individuals and closely held entities in federal and state criminal tax (including foreign-account and cryptocurrency) investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and white-collar criminal investigations including campaign finance, FARA, money laundering, and health care fraud.

[1] The Blockchain Analysis Company – Chainalysis at https://www.chainalysis.com/

[2] Home | Palantir at https://www.palantir.com/

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