The Criminal Investigation (CI) division of the IRS regularly investigates taxpayers who are suspected of tax evasion, tax fraud, and other offenses. These investigations may be related to tax audits, or they may be performed independently. Those who are accused of committing tax-related offenses may not only face penalties for non-payment of taxes or failure to submit the proper information to the IRS, but they may also be subject to criminal prosecution. In recent years, offenses related to cryptocurrency have been a significant concern for the IRS. Agency officials have stated that hundreds of cases involving virtual currency and tax evasion or other offenses are likely to be prosecuted within the next year.

The IRS's Increased Focus on Cryptocurrency

As more and more people invest in cryptocurrency, use virtual currencies to make payments and purchases, and receive digital assets as income, the IRS has begun to scrutinize these transactions and enforce compliance with tax laws. It has also been able to prosecute some major cases involving tax fraud and other related offenses. In just one example, the founders of Bitqyck, a cryptocurrency investment company, were convicted of tax evasion after defrauding investors of around $24 million. The defendants in this case had failed to file corporate tax returns, and they had underreported their income to the IRS, resulting in tax losses of more than $1.6 million. In addition to being sentenced to prison, the defendants were required to pay a civil penalty of $8.3 million to the U.S. Securities and Exchange Commission.

While high-profile cases prosecuted by the IRS that involve millions of dollars may receive the most attention in the news, the hundreds of cryptocurrency investigations that are currently being performed are likely to involve smaller amounts. Currently, the IRS is using "John Doe" summonses to gather information about cryptocurrency transactions, and in many cases, these summonses involve transactions of $20,000 or more. These summonses may be served on third parties, such as cryptocurrency exchanges, in order to identify virtual currency owners and determine whether they have violated tax laws. Summonses may be used to identify "off-ramping" transactions in which cryptocurrency is exchanged for legal currency issued by the U.S. or other countries, as well as virtual currency that was received as income and was not properly reported to the IRS.

The U.S. tax system is complex, and there are a variety of issues that could trigger tax audits by the IRS, potentially leading to penalties. Audits can be a significant area of concern for people who are self-employed or who own small businesses. In these situations, it is important to understand the information that a taxpayer will need to provide to the IRS and the issues that may be raised during an audit.

Audit Information Related to Profits, Losses, Deductions, and Expenses

During an audit, the IRS may request a variety of records or other information that supports the information reported on a tax return. These records may be related to:

• Income - All forms of income that a person earns must be reported to the IRS. It is important for self-employed taxpayers to maintain accurate records of all sources of income. This can sometimes be difficult for those who regularly conduct cash transactions. Large deposits into a bank account or major purchases made using cash may be reviewed by the IRS, and a taxpayer will usually need to provide documentation showing how these amounts were earned.

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California’s Employment Development Department (EDD) handles state payroll taxes, as well as unemployment benefits. While the EDD has struggled to address the large amount of unemployment insurance claims during the COVID-19 pandemic, it is beginning to return to normalcy, and it has resumed payroll tax audits. Businesses that are facing these types of audits will need to understand their requirements, as well as the post-audit issues that they may encounter.

Issues and Records Addressed in an EDD Audit

Audits performed by EDD will review a company’s records to ensure that wages and other payments made to employees have been reported correctly and that an employer is in compliance with its requirements under the California Unemployment Insurance Code (CUIC). An initial EDD audit will generally cover a period of up to 3 years, and it may review records for the 12 most recent quarters. Worker classification is one of the primary issues addressed in an audit, and it may determine whether workers have been incorrectly classified as independent contractors rather than employees. 

A business will be required to provide its records during an audit, usually starting with the following:

During the COVID-19 pandemic, many individuals, families, and businesses have experienced financial difficulties, and to help avoid additional strain that would affect the national economy, the IRS temporarily suspended some of the activities it usually takes to collect unpaid taxes. However now that the United States is emerging from this national emergency with many businesses reopening and people returning to work, the IRS has stated that it will be resuming its regular collection programs. Taxpayers who are facing tax audits or who have unpaid taxes will need to be aware of the potential types of actions that the IRS may take against them.

IRS Tax Enforcement Operations

As of June 15, 2021, the IRS has begun to return to its normal practices of collecting taxes. Typically, the IRS sends notices to taxpayers who have tax debts, informing them of the balance that is due. The IRS will be following up with those who have not responded to these notices. Those who have tax liabilities from tax returns filed for 2019 or 2020 are required to respond to notices from the IRS within 30 days, either by paying the amount due or requesting an offer in compromise or other forms of relief. This window is extended to 45 days for those who reside outside the United States. Beginning August 15, 2021, anyone who has failed to respond to a notice from the IRS may be subject to tax liens or levies.

Other tax levy programs will resume on July 15, 2021, including:

The Internal Revenue Service (IRS) regularly conducts tax audits of individual taxpayers and businesses. During an audit, it will seek to collect taxes that were underpaid due to misreported income, improper deductions, or other issues, as well as any applicable penalties. Under the administration of President Joe Biden, these efforts may increase, and the IRS will be looking to conduct more audits of individuals who earn high incomes or own significant assets, as well as large partnerships and corporations.

Increased IRS Budget and Focus on Closing the Tax Gap

President Biden recently announced the American Families Plan, a proposal that would increase infrastructure spending and provide aid to families with middle to low incomes. This proposal also included an increase in the IRS’s budget by $80 billion over 10 years. This increase would allow the IRS to conduct more audits and narrow the “tax gap,” or the difference between what U.S. taxpayers owe and what is actually collected. Experts believe that the tax gap is close to $1 trillion per year.

This proposal came on the heels of a report by the IRS and other economists which stated that taxpayers with income levels in the top 1% do not report 21% of the income they earn. This results in around $175 billion of taxes that go unpaid each year. In addition, the number of audits of taxpayers who earn at least $1 million per year has fallen by 80% over the past 10 years, making it less likely that the IRS will be able to collect the taxes owed by these taxpayers. Increased audit and collection efforts aimed at this top 1% may assist in narrowing the tax gap without additional tax increases.