According to a previously undisclosed Internal Revenue Service (“IRS”)
document, the IRS plans to spend $291 million updating 140 computer systems to
help it implement the new tax law. Those information-technology costs and other
back-office operations will consume more than 90% of the money Congress is
giving the IRS for implementation. Overall, the IRS budget is estimated to be
$11.4 billion in the next fiscal year.
For the IRS, keeping up with changes in the tax law and new technology
can be quite expensive. The internet has created many positive changes for the
IRS, including reducing costs for many services, such as tax return filing,
data analysis and the exchange of information. However, it seems that
once again a new technology revolution is upon us; blockchain.
Blockchain technology is based on the ideals of trust, security, speed,
and cost efficiency. A blockchain is a digital ledger and can be designed to
record any type of public or private transaction in real time. The most
widely used public blockchains involve cryptocurrencies, such as Bitcoin,
however, blockchain technology can be employed without the involvement of
cryptocurrency.
Cryptocurrency transactions, such as Bitcoin, are recorded in a
blockchain, which can be thought of as a worldwide digital spreadsheet or
ledger. Blockchain leverages the capital of a large peer-to peer network
to verify and approve each transaction. Blockchain is encrypted and can
be public or private. Blockchain encryption involves public and private keys
(much like a two-key system to a vault) to ensure security. Each time a
transaction is verified by a network, the transaction is stored in a block
which is linked to the preceding block, thus, creating a chain. Each
block must refer to the preceding block to be valid. In other words, if
you wanted to steal a Bitcoin, you would have to rewrite the coin’s entire
history on the blockchain.
Blockchain and its digital ledger platform can revolutionize the way
data is analyzed, exchanged and stored by the IRS. Blockchain can help the IRS
lower costs and increase security, as well as enhance the speed in which it
accesses and reviews taxpayer data. Here are just a few small examples of
some of the issues the IRS is currently experiencing.
The implementation of a private blockchain platform by the IRS can be
transformational from a speed, security, and cost perspective. Private
blockchain or distributed ledger technology, as referred to by the financial
services industry, can make the IRS a more cost effective and efficient
regulator. Because tax return data is highly private, a public blockchain
model, such as Bitcoin, would likely not be a suitable option for the IRS since
anyone would be able to access and interact with it. Whereas, a private
blockchain model would allow the IRS and only other permitted parties to view
the blockchain data. With a private blockchain model, transactions can be
verified privately or by approved third-party verifiers, removing the need for
anonymous miners who require a financial reward as well as the need for large
amounts of electricity.
For example, when a bank or financial institutions transfers 401(k) plan
funds to an IRA, the transaction can be verified and reported by the parties on
a blockchain so that the IRS will have immediate access to the data. The
same technology can be employed for almost all Form 1099 related transactions,
which amount to over one billion dollars a year, according to the IRS.
Likewise, a digital ledger platform could let the IRS or other government
regulators audit individuals or corporations in real time, giving them instant
access to financial or tax return related data. Moreover, using a private
blockchain platform will offer the IRS far more security against taxpayer
identity theft because of cryptography. Smart contracts technology can help the
IRS manage and enforce settlement agreements with taxpayers, as well as manage
various other agreements with individual and corporate taxpayers.
We have just started scratching the surface of the potential impact of
the blockchain revolution for all industries, including government agencies,
such as the IRS. As a 2016 PricewaterhouseCoopers (PWC) report
stated, “Distributed ledger technologies offer institutions a
once-in-a-generation opportunity to transform the industry to their benefit, or
not.” Blockchain technology can potentially provide the IRS with a greater
impact than E-filing. It will help the IRS save costs, allow for real time tax
related data analysis, reduce fraud, as well as help agents better manage
audits. The next time Congress is formulating a budget for the IRS, they would
be wise to consider the many benefits that blockchain technology related
investments can better the agency. Failing to do so could prove to be an IRS
nightmare.
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