Overview: IRS on Crypto Transactions
In 2014, the IRS went on record to state that it considered cryptocurrencies (virtual currencies) to be property subject to similar tax treatment as stocks and other securities. However, it hasn't taken hardline approaches to enforce the policy.
Is the IRS Increasing Focus on Cryptocurrency Transactions?
The IRS has, however, increased audits on US taxpayers who have cryptocurrency transactions. This is likely to increase going forward. In fact, the IRS has been actively outsourcing audit work to cryptocurrency experts. The main reason why the IRS will seek outside contractors is if it plans to increase cryptocurrency audit activities.
The IRS has also ramped up enforcement actions on cryptocurrency transactions. In 2017, the agency sued Coinbase – one of the biggest crypto exchanges globally, to get account information on Coinbase's account holders, who happened to be US taxpayers.
These efforts revealed that Coinbase had approximately 6 million US-based customers from 2013 to 2015, yet only 1,000 filed returns which included their cryptocurrency gains. In 2018, Coinbase gave the IRS personal information belonging to approximately 13,000 account holders as part of the litigation.
Based on this information, the IRS sent approximately 10,000 letters to cryptocurrency account holders, notifying them that they were supposed to report their crypto gains and amend previously filed returns. While some people who got the letters didn't have issues with their tax returns, the effort reminded crypto account holders that they could face IRS issues like audits for failing to report cryptocurrency transactions.
What Triggers an IRS Audit?
The IRS utilizes advanced technologies like data mining, AI (Artificial Intelligence), and more to identify tax returns that need to be audited. The IRS' automated systems can detect many tax crimes or wrongdoing, including underreporting income.
The system can automatically compare income reported on tax returns with income on 1098, 1096, 1099, and W-2 forms. If returns don't match income identified in any of the forms, the return is automatically flagged, triggering an audit.
Most audits are computer-driven and solvable by calculating new tax, penalties, and interest linked to unreported income. Cryptocurrency traders who are US taxpayers tend to trigger audits because they don't report forms 1099-K/1099-B provided by cryptocurrency exchanges when filing their returns.
What Should I Do If I Haven't Fully Reported My Cryptocurrency Income to the IRS?
If you discover you haven't reported your crypto income fully or correctly over the years, you can start by understanding the IRS' approach. First and foremost, the IRS has legal powers to audit any US taxpayer's personal finances and establish if they have underreported their cryptocurrency income.
If an IRS audit reveals underreporting, you will be contacted and asked to pay the amount you were supposed to pay if you reported crypto income correctly. The IRS also expects you to pay interest on the unpaid tax and may impose civil penalties. In typical civil cases linked to negligence, the penalty is 20% of the owed taxes.
However, fraud cases attract higher penalties (up to 75% of owed taxes). The IRS may not charge anything for recent tax returns that can be corrected. However, old returns are likely to attract penalties when amended. You may also require professional help.
It is recommendable to talk to an attorney experienced in cryptocurrency tax matters to assist you through both processes. An attorney can stop your case from degenerating into a criminal case. He/she will also help you through the civil disclosure process and offer other options.
Should I Go to My Accountant on Cryptocurrency Transaction Tax Matters?
Most crypto transaction reporting issues are treated as civil matters by the IRS. Failing to report a transaction you don't fully comprehend doesn't usually result in a criminal matter. However, you should comprehend the criminal consequences of purposefully evading taxes.
If you know you should report your crypto income but fail to report, you can face criminal charges for tax evasion. If you have reason to believe you have criminal exposure because you underreported your cryptocurrency income, consult a criminal tax defense lawyer immediately for IRS audit defense strategies.
It isn't advisable to go to your accountant on crypto transaction-related tax liability since you won't enjoy attorney-client privilege on such matters. Your accountant can be required to testify and share such information with investigators.
Is it Important to Maintain Accurate, Up-To-Date Cryptocurrency Transaction Records?
Absolutely. Having your own records is critical. However, individuals who are constantly trading can have a hard time accurately tracking their transactions. However, some crypto exchanges will offer tax forms for reporting cryptocurrency gains on all crypto holdings.
If you plan to trade and want to avoid IRS cryptocurrency audits, you should invest in crypto management software that offers audit support for tracking transactions and recording gains/losses accurately from every trade. Being proactive about your crypto transaction records is critical when fighting IRS investigations, charges, and penalties linked to underreporting cryptocurrency income and related matters.
What Does the IRS Ask for in Audit Requests Involving Cryptocurrency Transactions?
An IRS audit request on crypto matters can focus on many things. It will generally involve disclosures of all accounts, such as wallet IDs, crypto exchange accounts, blockchain addresses, and transaction details varying in scope. You may also be compelled to offer documentation such as correspondence with counterparties in certain cryptocurrency transactions.
In a nutshell, persons who receive correspondence from the IRS on cryptocurrency tax matters should contact an experienced IRS audit defense attorney to offer tax audit defense services. Seasoned tax attorneys experienced in cryptocurrency transactions are best suited to navigate IRS audits and ensure investigations don't become criminal charges. Having an experienced legal expert guiding you will ensure you don't make common mistakes that worsen your cryptocurrency tax problems.
