If you caught the news this morning, the big kerfuffle was about how the IRS will dramatically grow the number of auditors and agents it uses to enforce tax laws in the U.S. if the Inflation Reduction Act gets enacted. Yesterday (Sunday), the draft legislation was able to get through the Senate, and many believe it will now be a slam-dunk in the Democrat-controlled House and an easy signature for the President who favor government growth with the funding. Specifically, among other provisions, the proposed Act will park a permanent $80 billion in the IRS to ramp up hiring of 87,000 new agents as well as auditors, all intended to recapture an annual $124 billion missing in taxes owed currently. Since there are only something under 1,000 real billionaires in the country, as one radio show put in response, it's pretty damn clear the rest of the 86,000 agents will be working on the taxes and financial activities of the average person. Generally, anyone who is making more than $50,000 annually (the practical threshold of when personal income taxes start to apply) will be in the target bucket. However, the potential growth of the IRS is part of a bigger picture and reaction to crypto taking place.

Up to now, much of the government movements in regulating crypto has been within existing legal frameworks or current grey areas. Britain was probably the first out of the gate, forcing many players to either align with its banking charter system or get out. Binance was then the next big target, with a number of national governments forcing the exchange to plant physical roots somewhere and stop playing the nonsense game of “we’re digital and have no headquarters.” The U.S. Securities Exchange Commission (SEC) has since been rattling cages by going after De-Fi outfits and putting big exchanges on notice that they are pretty much next, whenever the SEC managers get done hiring enough lawyers and can put their new task units to the test.

However, again, all of the above is under existing framework. What really will be the gamechanger will involve new laws and system reaches by government into the daily lives of people to track what they are doing with crypto-related finances. One particular aspect that works in the government’s favor is the fact that most blockchains are public. While wallet addresses are, essentially, a string of letters and numbers in a unique identifier, they are specific to a given wallet. Once the government knows who owns the wallet, it’s a very simple matter of identifying all the transactions that wallet has had. How would the government do that? Simple, by adding a line in the income tax return required filing that people have to report their wallet addresses. It’s that easy.

Here's an example already in practice. Back in 2013 the IRS through a whistleblower gained access to a major provider of Swiss bank accounts. Once that famous barrier had been broken and the agency had access to people’s hidden offshore money accounts, it became apparent how widespread the money-hiding game was. So, to put people on notice, the IRS added a filing requirement now seen every year on its forms, generally requiring the filer to state if he or she owns any foreign accounts and report their interest especially if over $10,000 in value. If not, and it turns out the accounts exist, the person could be criminally prosecuted. It’s a simple line with a simple box to check, nothing more. But the ramifications are extremely powerful.

When it comes to crypto accounts, the same has already appeared in the 2021 income tax software. It's a subtle question, but essentially the taxpayer is asked to identify whether he or she has engaged in crypto transactions. Again, subtle, a one-line question to answer with a yes/no box, but the ramifications are huge for personal liability. It’s not that far of a leap to expect wallet addresses to be identified next for further tracking, particularly by the IRS for enhancing their tracking.

On the institutional side, the pieces are already in place with KYC compliance to force major exchanges and finance entities to comply with user tracking. In other countries like England, firms are already getting thumped for not maintaining compliance and having to respond to audits. In the U.S. the KYC requirements paves the way for tax reporting. The Infrastructure Act of 2021 has flagged the open barn door for the Treasury Department to pursue new regulations on compliance. The most notable for the average person will be the proposed creation of the IRS 1099-DA form. 1099s represent a variety of tax forms entities have to issue to users and workers for payments they have received in the previous tax year. These range from agricultural income to royalties to miscellaneous contracting income. The proposed 1099-DA will be specific to crypto payments and income paid to account-holders of exchanges and De-Fi operators. It is intended to wipe out the current confusion whether someone owes something or not if they didn't get a 1099 for their activities. Again, the power of the 1099 is tremendous in its data value; 1099s are regularly matched by computer with the recipient and the taxes they report on income tax filings. Where there is a discrepancy, it can trigger an audit if the person under-reported taxes due.

All of the above will make it harder to make a profit with crypto for anyone expecting big gains. However, technically, the taxes were always owed; the government is simply becoming better at enforcing it. As a rule of thumb, one can pretty much expect to turn over 20% of net profits, and should probably put that aside as a gain is made. It's owed at the end of the year whether one still has the money afterwards or not. For the institutional structure of crypto, however, government regulation is likely going to shut down many of the creative avenues that have been a bit of the wild, wild west with huge gains and huge risks. Worst, the regulation will do little, predictably, to stop the huge hacks to those entities as well. Once engaged in a digital theft, why would the perpetrator give a darn about forms, KYC and regulation requirements? 

So, my prediction is:

• Expect a huge volume of data capture on crypto activities by 2025, getting down to a very personal level.
• Don't be surprised by a lot of crypto services and resources shutting down rather than dealing with regulation.
• Be prepared for a flood of black market activity as folks who don't want to be known shift to untracked exchanges and channels.

And for the rest of us, crypto will be more difficult to do "right," as well as probably becoming a lot more boring.