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How to Avoid IRS Cryptocurrency Audit Triggers: Forms to File, Red Flags, and More
|Last Updated on: 29th September 2023, 09:12 am
How to Avoid IRS Cryptocurrency Audit Triggers: Forms to File, Red Flags, and More
Dealing with cryptocurrency can be tricky when it comes to taxes. The IRS is cracking down on unreported crypto income and transactions. No one wants the stress and hassle of being audited. So how can you avoid crypto tax audit triggers? This article will break it down into easy, digestible bits. Let’s dive in!
Failing to Report Crypto Transactions
One of the biggest red flags is failing to report your crypto transactions and income accurately. Even if it was just a little bit of income from mining or staking rewards. The IRS wants to know about all of it! They even sent letters to thousands of taxpayers asking about their crypto activity. Yikes!
The best way to avoid issues is to report everything – and be honest! Use crypto tax software like TokenTax to generate your required tax forms. It will track and calculate your gains, income, losses, and more from all your wallets and exchanges. Then you can easily file accurate returns. The IRS will be happy 🙂
Making Big Transactions or Gains
Let’s say you sold a bunch of Bitcoin and made $100k in capital gains. Or you bought a Tesla with crypto. Big transactions like these can raise eyebrows. The IRS may wonder where all that money came from if it’s not reported properly on your tax return.
Again, the solution here is reporting accurately! Don’t try to hide large amounts of income or gains. Be transparent on your taxes. The IRS has access to records from exchanges showing your transactions. So they’ll eventually find out anyway!
Inconsistencies and Discrepancies
Another thing that can trigger audits is having inconsistencies or discrepancies on your tax return related to crypto. For example, maybe you reported $5k of Bitcoin sales on your return but the IRS records show $10k of sales from Coinbase. Uh oh! Or maybe you claimed a loss on a crypto sale but didn’t report the initial purchase. Big red flag.
These kinds of inconsistencies make the IRS suspect you’re hiding something. The best way to avoid issues is double checking your return against your transaction records. Make sure all the amounts match up and you reported both sides of transactions – purchases and sales. Consider getting help from a crypto tax professional to be safe.
Using Privacy Coins
Coins like Monero and Zcash that focus on privacy and anonymity are another audit trigger. The IRS is very suspicious of these! They make it much harder to track transactions and income. So heavy use of privacy coins may lead the IRS to take a closer look at your return.
If you do use privacy coins, take extra care to track your transactions and report income accurately. You may need to provide more detailed record keeping than usual to back up your return if audited. Consider avoiding large volume transactions in privacy coins altogether to be safe.
Trading on Offshore Exchanges
The IRS really doesn’t like it when US taxpayers use offshore or foreign crypto exchanges. These exchanges don’t follow the same reporting rules as US-based platforms. So the IRS has a harder time verifying your activity.
To avoid extra scrutiny, stick to well-known American exchanges like Coinbase, Kraken, Gemini, etc. They will issue you 1099 forms reporting your transactions to the IRS. This provides an extra layer of transparency.
How to Prepare for a Crypto Tax Audit
Even if you do everything right, there’s still a chance of being audited. The IRS is randomly selecting more and more tax returns for review. So it’s important to be prepared just in case! Here are some tips:
- Keep detailed records – Save all your transaction histories, 1099 forms, receipts, etc.
- Use crypto tax software – This creates an audit trail showing how your return was calculated
- Hire a tax pro – They can help represent you if you do get audited
- Respond promptly – Don’t ignore any IRS letters requesting information
- Be honest and transparent – This reduces penalties if discrepancies are found
Following these tips will help you survive a crypto tax audit with minimal stress or issues. You’ll have everything you need to provide the IRS to back up your return. Just be thorough and honest!
Correcting Past Returns
What if you realize you didn’t report your crypto activity properly in previous tax years? That can definitely trigger an audit if the IRS catches those errors. But you can get ahead of it by taking action yourself to correct past mistakes.
You’ll need to file amended returns for any years with unreported or inaccurate crypto transactions. Use Form 1040X to do this. Be sure to calculate any additional tax owed from unreported gains. You’ll have to pay back taxes and interest on the amounts due.
It’s best to consult a tax professional here if possible. An expert can help make sure you file complete and accurate amended returns. This shows good faith to the IRS that you’re fixing your past mistakes proactively. And it may help reduce penalties.
Penalties for Inaccurate Reporting
What kinds of penalties could you be facing if the IRS catches unreported crypto income or transactions? Here are some common ones:
- Accuracy penalties – 20% of the underpaid tax if due to negligence
- Civil fraud penalties – 75% of the underpaid tax if IRS proves intentional deceit
- Failure to file penalties – 5% per month of unfiled returns up to 25%
- Failure to pay penalties – 0.5% per month of unpaid taxes up to 25%
Yikes! Those penalties add up fast. It’s really important to file accurately and pay any tax owed on time. Otherwise you could end up owing much more than your original tax liability. The IRS charges interest on penalties too.
Avoiding Criminal Charges
Could you actually go to jail for tax evasion related to crypto? Unfortunately yes, it is possible in severe cases. Intentionally failing to report large amounts of crypto income or gains could potentially lead to criminal charges.
Any civil tax fraud penalties over $10,000 get referred for possible criminal investigation. So large amounts of unreported crypto activity make you more at risk of criminal prosecution. Not to mention if the IRS suspects you intentionally hid offshore crypto assets.
The best way to avoid criminal tax issues is being transparent on your returns. Don’t try hiding anything from the IRS! Report all income, gains, losses, and transactions accurately. And consult a tax attorney right away if you receive any criminal investigation notice from the IRS. Don’t mess around when it comes to potential jail time!
Hiring Tax Help
With all the complexities and risks involved, it’s highly recommended to get tax help when dealing with crypto. Consider hiring:
- Crypto tax software – Automates transaction tracking and tax reporting
- CPA or Enrolled Agent – Provides expert guidance on reporting properly
- Tax attorney – Helps with audits and appeals if you get into trouble
Having the right tax help on your side can provide peace of mind that your crypto taxes are being handled correctly. And they’ll know exactly what to do if you ever do get that dreaded audit letter from the IRS!
The Bottom Line
Dealing with cryptocurrency taxes can seem intimidating. But following the guidance in this article will help you avoid common audit triggers. Just remember:
- Report all crypto income, gains, losses, and transactions accurately
- Keep thorough records to support your return
- Use crypto tax software to eliminate errors
- Don’t try hiding anything! Transparency is key
Do your diligence upfront and you’ll sleep better knowing your crypto taxes are audit-proof. No one wants surprise IRS letters. So take steps to avoid them. Your wallet and peace of mind will thank you!