18 Sep 23

How to Handle IRS Letters and Notices About Cryptocurrency Tax Reporting Issues

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Last Updated on: 18th September 2023, 09:35 pm

How to Handle IRS Letters and Notices About Cryptocurrency Tax Reporting Issues

Dealing with the IRS about cryptocurrency taxes can be intimidating. You might feel anxious when you get an IRS letter in the mail, or confused about how to respond. Don’t worry! This article will walk you through what to do step-by-step if you get an IRS notice related to crypto taxes.

Why Did I Get an IRS Letter About Cryptocurrency?

The IRS has been ramping up enforcement around cryptocurrency tax reporting. In 2019, they started sending letters to crypto owners who may have failed to report income or pay taxes. There are three main reasons you might get a letter:

  • You didn’t report crypto transactions on your tax return
  • You didn’t pay enough tax based on your crypto income
  • The IRS received information from exchanges or third parties that doesn’t match your tax return

For example, if you bought and sold cryptocurrency through an exchange like Coinbase, they are required to send Form 1099-K to you and the IRS reporting your transactions if you meet certain thresholds. If the IRS notices your tax return doesn’t match the 1099-K, they may send a letter asking for an explanation.

What Are the Different Types of IRS Letters About Cryptocurrency?

There are a few common letters the IRS sends related to virtual currency:

Letter 6173

This is an “educational letter” letting you know your federal tax returns need to properly report virtual currency transactions. It requests you file amended returns to correct any past errors.

Letter 6174

This letter says the IRS has “information that you have or had one or more accounts containing virtual currency and may not have met your U.S. tax filing and reporting requirements.” It requests you review your past returns and file amended returns if needed.

Letter 6174-A

This is a “soft notice” indicating the IRS identified potential virtual currency tax non-compliance based on third-party information reports like Form 1099-K. It gives you a chance to review before further enforcement action.

Letter 6173-A

This letter indicates the IRS found you failed to report income from virtual currency transactions. It asks you to pay back taxes and interest or respond with an explanation.

What Should I Do When I Get an IRS Letter About Cryptocurrency?

Don’t panic! The IRS letters may seem intimidating, but the most important thing is to respond appropriately. Here are the steps to take:

  1. Read the letter carefully and understand what the IRS is requesting of you.
  2. Review your past tax returns to identify any potential errors or omissions related to cryptocurrency income.
  3. Calculate the taxes you should have paid based on your crypto transactions.
  4. Depending on the letter, file amended tax returns and pay any additional tax and interest owed.
  5. Respond to the IRS with an explanation if you disagree with their findings.

It’s wise to consult a tax professional like a CPA or tax attorney if you receive an IRS notice about cryptocurrency. They can help make sure you respond appropriately.

How Do I File Amended Returns to Address IRS Cryptocurrency Issues?

If the IRS letter requests you file amended returns, you’ll need to use Form 1040-X to correct any errors or omissions. Here’s the process:

  1. Collect records of all your cryptocurrency transactions from the tax years in question, including exchange records, wallet statements, etc.
  2. Identify which tax returns need amending based on the transactions.
  3. Recalculate your income, gains, losses, and tax owed.
  4. Complete Form 1040-X for each year, explaining the specific changes being made.
  5. Include any additional tax payment due with interest.
  6. File the amended returns with the IRS.

Make sure to be thorough and disclose all relevant crypto transactions when amending – the IRS will likely follow up to confirm you made all necessary corrections.

What If I Don’t Agree With the IRS Findings in the Letter?

You have the right to challenge the IRS if you disagree with the findings in their notice. Your response options include:

  • Provide an explanation – You can send a written statement explaining why you don’t agree and believe your taxes were done correctly.
  • Request an appeal – You may request an appeal with the IRS Office of Appeals to review your case.
  • Petition the U.S. Tax Court – For legal disagreements, you can petition the Tax Court before having to pay disputed tax.

It’s wise to consult a tax attorney to understand your rights and best response options. Be aware the IRS may assess penalties and interest if you are found to underpay your taxes.

What Are the Penalties for Not Reporting Cryptocurrency Income?

If the IRS determines you failed to report cryptocurrency transactions or underpaid your taxes, you may face:

  • The accuracy penalty – 20% of the underpaid tax
  • The failure to file penalty – 5% per month up to 25%
  • Interest charges on late payments
  • Criminal penalties in cases of tax evasion

The penalties can add up fast. It’s critical to consult a tax expert and file amended returns if the IRS identifies unreported crypto income.

How Can I Avoid IRS Enforcement Around Cryptocurrency in the Future?

The best way to steer clear of IRS letters and penalties is to fully report your crypto activity on your tax return each year. Follow these best practices:

  • Keep detailed records of all crypto transactions
  • Track purchase dates, cost basis, fair market values, and sale prices
  • Use crypto tax software to generate complete gain/loss reports
  • Disclose all crypto income sources like mining, staking, and airdrops
  • Classify crypto appropriately as property, investment, business income, etc.
  • Report on correct IRS forms – 8949, Schedule D, Form 1040
  • File FBAR if you hold crypto in foreign exchanges or wallets
  • Consult a tax pro if you have complex crypto tax situations

Following the IRS guidance for cryptocurrency reporting is essential. In Notice 2014-21, the IRS stated virtual currency should be treated as property for tax purposes. That means:

  • Purchasing crypto is not a taxable event
  • Trading, selling, or spending crypto may trigger capital gains/losses
  • Mining and staking rewards are taxed as income
  • Cryptocurrency is subject to wash sale and capital loss limitation rules

Take reporting seriously – the IRS is cracking down on unreported crypto activity. Fully disclosing your transactions protects you from penalties and enforcement.

Consult a knowledgeable tax professional if you need help ensuring you meet all IRS virtual currency reporting requirements. With proper reporting, you can avoid unnecessary IRS letters and sleep better knowing your crypto taxes are covered.