IRS Audit Letters
The IRS has recently sent letters to taxpayers titled “Reporting Virtual Currency Transactions” stating “[w]e have information that you have or had one or more accounts containing virtual currency but may not know the requirements for reporting transactions involving virtual currency.” The IRS further states “[i]f you do not accurately report your virtual currency transactions, you may be subject to future civil and criminal enforcement activity.” Depending on the taxpayers scenario the letter may be titled IRS 6173, IRS 6174, IRS 6174-A, or CP2000.
How Does the IRS Know that I Own Virtual Currency?
The IRS has multiple methods to determine whether a taxpayer owns virtual currency. The most common include: 1) disclosure through the virtual currency question on Form 1040; and 2) information reported from exchanges.
In 2019, taxpayers who filled out Sch 1. of Form 1040 were required to disclose if “[a]t any time during [the year], did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency.” It should be noted that, for 2020, the IRS has moved the Virtual Currency question to page 1 of Form 1040, which means that every taxpayer will have to attest whether they had any form of Virtual Currency activity during the year.
If a taxpayer discloses that they had an interest in virtual currencies, but fails to file an IRS Form 8949 for the applicable tax year, then they will likely receive a letter titled Reporting Virtual Currency Transactions, IRS 6173, 6174 or 6174-A. If you receive one of these letters then you will need to amend your prior tax returns to include your virtual currency tax forms.
TaxBit has encountered some users who presumably received this letter because they disclosed that they acquired virtual currency, but they did not engage in a sale or trade that resulted in a taxable event. Accordingly, in this situation the taxpayer does not have any taxable events to report. This can occur due to the virtual currency question being overbroad, rather than only asking if you had a reportable tax obligation arising from virtual currency. If this occurs then TaxBit is able to resolve these IRS letters by showing that a user did not dispose of any cryptocurrency during the applicable tax year.
Cryptocurrency exchanges have certain information reporting requirements, also referred to as 1099’s, that they provide to users and to the IRS. Exchanges are required to provide their users with these information reporting tax forms in order to provide them with the information necessary to report their taxes. Some common 1099’s in cryptocurrency include (1099-B for trading activity, 1099-INT for interest earned, 1099-DIV for dividend income, and 1099-K for selling goods and services transactions).
The IRS will cross-check the information reported by the exchange to the taxpayer’s tax return. If there is a matching issue then the IRS will send the taxpayer a CP2000 letter, which will require the taxpayer to respond.
Historically, some exchanges have issued Form 1099-K, which was never intended for virtual trading activity. The correct tax form for virtual currency trading is Form 1099-B. If you received a Form 1099-K then you will likely receive a CP2000 letter two years later, regardless of whether you reported your trading activity or not. This is due to the fact that Form 1099-K relates to payments received from a third party payment processor and has nothing to do with the tax implications from trading capital assets. If you received a Form 1099-K from an exchange and have subsequently received a CP2000 letter then TaxBit can help resolve the issue. (See article explaining the issues with Form 1099-K for virtual currency transactions). Most exchanges have seen the problems created by filing Form 1099-K and are starting to issue Form 1099-B, which more accurately reflects the economics of cryptocurrency trading.
If you received a letter from the IRS regarding your cryptocurrency activity, then please reach out. TaxBit’s team of tax experts stand ready to help you resolve the issue.