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A friend of mine is looking to trade crptocurrencies and I subsequently warned him that he'll have to keep careful track of all of his transactions throughout the year because he would have a lot of paperwork come tax time. He jokingly mentioned that he'd wait for the IRS to send him a letter and then figure it out. This inspired me to look into how the IRS would even know that he had earned income by selling crypto and then I realized that at least one major exchange (Coinbase) doesn't report anything to the IRS for trades.

Their tax page is littered with disclaimers of "you should pay your taxes", but there's no effort on their - or other exchanges - part to actually inform the IRS of tax liability. Coming from a background of stock trading, this is absolutely insane to me. I can't imagine a world where I could day-trade stocks on Etrade and never be compelled to report it to the IRS; or taking distributions from a 401K and then pay nothing because the IRS doesn't know I did it. Obviously this is illegal, but without reporting systems in place I have to imagine that compliance would be insanely low - it's why the IRS has mandatory reporting for the rest of the financial market. The IRS knows when my bank pays me $11 in interest, but it wouldn't know when I made 200K selling Bitcoin. There's billions of dollars in active trading going on every year in crypto markets and all of it is completely outside the knowledge of the IRS.

Is crypto tax enforcement entirely dependent on random, individual audits? How do crypto exchanges evade the same level of responsibility/regulation of equity markets or banking?

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How do crypto exchanges evade the same level of responsibility/regulation of equity markets or banking?

Regulation, in general, is not the same thing as required tax reporting (or actual tax, for that matter).

Who is and is not required to do information reporting and in which cases is set out, usually in detail, in the law enacted by Congress, interpreted where necessary by regulations adopted by the Treasury department. IRS doesn't get to decide. The laws weren't written to explicitly include cryptocurrency exchanges, probably because they didn't exist when these laws were written and Congress isn't psychic or omniscient, and Treasury at least so far hasn't asserted they can be interpreted to do so.

Treasury does assert that the anti-money laundering laws (the old Bank Secrecy Act and the post-9/11 'USA PATRIOT' act) apply to cryptocurrency exchanges as 'money service businesses'

Is crypto tax enforcement entirely dependent on random, individual audits?

Not random; the only random audits IRS does are what is now called the National Research Program, and before 'restructuring' in 1998 was more straightforwardly called the Taxpayer Compliance Measurement Program. This does full 'audits' on a small random sample -- about 1 in 10,000 returns -- to allow statistical projection to the whole population. Because audits (formally 'examinations') are expensive, they otherwise try to focus based on estimates of 'audit potential' -- how much noncompliance they can find and assess (and hopefully collect) for a given amount of effort.

And they certainly do recognize cryptocurrency as such a 'potential' area. They also like to use less expensive methods to 'encourage' compliance, especially what are called 'soft letters'. Instead of manually analyzing your info in detail -- with checks to make sure they don't miss anything, because they're only allowed to examine a given return once -- they just send a computer-generated letter saying "we think maybe you didn't comply" and suggest they might audit; if the taxpayer responds by amending their return, they win at very low cost, and if not, they still have the choice to audit if they decide it's worth the cost. See https://www.irs.gov/newsroom/irs-has-begun-sending-letters-to-virtual-currency-owners-advising-them-to-pay-back-taxes-file-amended-returns-part-of-agencys-larger-efforts -- although the Taxpayer Advocate office, essentially an internal ombudsperson, considers this abusive; see https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/JRC21_SAO_05.pdf . And people certainly have been receiving these letters; googling "IRS letter 6173" gets me "about 45,000 results".

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