Crypto Tax Audit and Preventive Measures

On: May 24, 2023

How can I know if I am subject to a Cryptocurrency audit?  To determine whether you are selected for a cryptocurrency audit you will need to check your federal income tax returns from 2013 to 2017 and your virtual currency transactions for the same years for any unreported capital gains or unreported income. If you did not include any cryptocurrency transactions on your tax return as capital gains or losses, then you may be subject to an audit. With the IRS staffing being increased through federal funding the audit rates may increase, especially in cryptocurrency because of the Worldwide implications.

Why is the IRS now talking about Crypto tax audits?   Based on the history of virtual currency, Bitcoin became a medium of virtual currency in 2009, later Bitcoin Cash was a reality in 2017.  Another virtual currency named Ethereum became active in 2015 and Coinbase was another virtual currency operation used by many in the US and around the World.  In 2017, Coinbase had 5.9 million customers with $6 billion worth of Bitcoin exchanges. The same year, the IRS reported that less than 900 taxpayers reported exchanges in their IRS Form 8949. The court case in 2017 between the IRS and Coinbase may have triggered these audits. Leading Tax Group has Retired IRS Auditors on staff who can help you with a Crypto Tax Audit Notice.

What steps has the IRS taken to track virtual currency users?  In 2020, the IRS updated the IRS Tax Form 1040 to add a box for taxpayers to report virtual currency to answer “yes” or “no”.  It may be that you did not need to mark the box if you only purchased virtual currency with real US currency or held virtual currency in a wallet you do not need to check the box on IRS Form 1040.  In other cases, taxpayers who did not mark “yes” and had taxable gains in dealing with cryptocurrency transactions may be subject to this type of audit. Taxpayers can face additional tax, penalties and interest because of unreported capital gains, or unreported income on a tax return.

When did the IRS summons Coinbase for customer account information?  The IRS served a summons on Coinbase seeking records regarding all its customers. Coinbase refused to comply. The IRS narrowed the scope of the records request, and Coinbase again refused to comply. The court determined that the IRS had a legitimate purpose of investigating unreported virtual currency transactions and therefore ordered Coinbase to produce documents on 14,000 customers who had at least $20,000 in any one transaction in one year between 2013 and 2015 (United States v. Coinbase, Inc., United States District Court Northern California, November 28, 2017).

Can you tell me what IRS letter I may receive for a Crypto Tax Audit?  The IRS will send out one of three letters to taxpayers to file a delinquent or past due tax return or amend a previous year tax return. The IRS has developed three written letters which will be mailed out to taxpayers to respond to. They are Letter 6173, Letter 6174, or Letter 6174-A. Taxpayers who are required to file a tax return either because they never filed, or underreported income or did not mark “yes” or “no” should report virtual currency on IRS Form 1040, mark the appropriate box and include either Schedule C, Schedule D, or Schedule E.  In a crypto tax audit taxpayers should seek representation from experienced and qualified former IRS attorneys at Leading Tax Group.

Is Cryptocurrency income considered taxable income?  Yes, Mining income is subject to self-employment which constitutes a trade or business.  This determination has been made by the Internal Revenue Service. To report self-employment income and you are a single member business like a Sole Proprietor, then you file a IRS Form 1040, Schedule C. a Schedule D, or a Schedule E depending on which schedule applies to the taxpayer.  To amend an income tax return, you need information from your original tax return, file a Form 1040X and possibly avoid a Crypto Tax Audit.  You may still be subject to penalties if you never filed a tax return or underreported taxable income for a year you receive one of the three letters mentioned above.

What are some of the IRS penalties I may be faced with?  The IRS has penalties such as the Accuracy Related Penalty where 20% of any underpayment due to negligence or substantial understatement can be charged.  The Failure to File Penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty won’t exceed 25% of your unpaid taxes. A Failure to Furnish a Correct Payee Statement Penalty which is failing to file a correct information return on time or provide correct payee statement for 2022 is $50 per return up to 30 days later, for 31 days or later through August 1^st can be up to $110 per return. This penalty increases the later it is filed. A notice of underreported income by the IRS is done through a CP2000 Notice where the IRS send out a Notice of Proposed Change to Your Tax Return and gives 30 days to respond to “Agree” or “Disagree” with the proposed change.