what happened
The IRS is actively pursuing non-compliance related to cryptocurrency transactions. In 2019, the IRS sent more than 10,000 tax notices to non-compliant taxpayers. In mid-2020, he sent another tax notice to suspicious taxpayers. In 2021, the letter was not sent, though the push was more due to the IRS' shift to remote work and incentive issues than lack of attention.
Most of these efforts are aimed at reducing returns for crypto traders and investors. However, with the market retreating this year, the IRS believes traders are more likely to exaggerate their losses in an effort to lower their tax bills.
Additionally, with the passage of the Inflationary Reduction Act (IRA) in August, IRS audit efforts are expected to increase. The act earmarked $45 trillion for law enforcement, including "monitoring and enforcement of digital assets." Over the next decade, the agency will invest these funds in equipment and personnel involved in auditing and tax collection.
In light of these developments, taxpayers may be concerned that they will be subject to IRS scrutiny regarding cryptocurrency transactions. Knowing about IRS checks and how to avoid them can ease some of your fears.
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Types of IRS Checks
There are four types of IRS audits.
External check.
Compliance reviews are the most common type conducted by the IRS. They account for about 75% of the service's tax audits, and so far they are the only type of crypto audit based on current information from the IRS. As the name suggests, these checks are done through mail. Mailed requests usually require additional evidence to support certain amounts shown on your tax return.
For example, in 2019, the IRS sent a letter to 6173 taxpayers who were subpoenaed by Coinbase to provide detailed profit and loss accounts on reported gains and losses on cryptocurrencies. . At Coinbase's request, more than 10,000 taxpayers received tax notices (Letter 6173, Letter 6174, and Letter 6174-A).
IRS office check
IRS office audits are in-person meetings held at Internal Revenue Service offices. As part of this check, you must visit the designated IRS office and submit the documents requested by the checker.
IRS field checks
Field inspections are more serious than remote and camera inspections. This is done at your home (or office) for proper documentation. Often, such checks are carried out by organizations (as opposed to individuals).
Audit of Taxpayer Compliance Assessment Program (PCMP).
A TCMP audit is one of the most demanding audits and can be frustrating for taxpayers. Here, the IRS examines all the details of the taxpayer's tax return and reconciles the data with the source rather than examining a specific portion of the information.
How You Can Support Crypto Tax Audits
Cryptocurrency holders may initiate an IRS audit under the following circumstances.
1099 differences
Crypto exchanges can issue three tax forms: Form 1099-K, Form 1099-B, and Form 1099-MISC. If you do not claim the amount shown on these forms on your tax return, you will receive a CP2000 letter and an associated check.
For example, let's say you made $1,000 in stock market distributions and received a Form 1099-MISC showing that amount. If you file a tax return that does not include this amount, the IRS (Automated Underreporting (AUR)) computer system will automatically report $1,000 on your tax return. The same principles apply if you received a Form 1099-B or 1099-K and did not fill it out correctly.
Therefore, when you receive a tax return from the exchange, the IRS already has a copy of it and you must report it to avoid compliance verification.
Information obtained through subpoenas issued by exchanges
The IRS relies on subpoenaed information to verify cryptocurrency holders. For example, in 2018, Coinbase was required to disclose about 13,000 user accounts, tax IDs, names, dates of birth, addresses, records of account activity, transactions and all periodic statements or invoices (or equivalent), according to John's subpoena. Dow. In 2021, the IRS sent a subpoena to San Francisco-based cryptocurrency exchange Kraken's John Doe requesting information regarding "an investigation into a designated group or class of individuals" that the IRS has reasonable grounds to believe "may not be followed." In 2022, another Los Angeles-based exchange, SFOX, was ordered to release information about certain cryptocurrency users.
Random selection
In addition to reporting 1099 errors and citations, you may also be selected for a random review.
According to the IRS, "Sometimes earnings are selected based solely on a statistical formula. We compare your tax return to "standards" for similar returns. We develop these "standards" based on audits of a statistically accurate random sample of returns. .Research conducted by the National IRS Program
For example, let's say you reported $50,000 in annual income over the last few years. However, in 2021, you reported a $2 million cryptocurrency profit because the coins you initially invested in made a huge profit. In this case, you may be eligible for an audit (even if you file accurate reports) because your tax return is exceptional compared to the average taxpayer earning $50,000 a year.
The same principles can be applied to offsetting large losses in bear markets. Reported losses are scrutinized more closely than gains because they result in lower overall tax revenue and higher tax refunds. As the market has fallen in recent months, the IRS may require tax returns that exceed the amount of the loss.
Tax loss harvesting allows you to sell your underwater digital assets and claim capital losses that can offset your gains. It is a legal practice followed by investors in the cryptocurrency and equity industries. These damages remain valid as long as the market conditions under which the property is sold to the related party remain unchanged.
However, in extreme bear markets, attackers may be tempted to fraudulently claim tax losses to create artificial losses. For example, they can create artificial losses by selling Gulf assets at deep discounts. This is fairly easy to do in the crypto space due to anonymity.
For example, Sam Wallet Anne has $1 million worth of NFTs Sam has another wallet called Wallet B. Sam can "sell" $100,000 worth of NFTs in Wallet B and fraudulently claim a loss of $900,000 ($100,000-$1,000,000). Such large and fraudulent losses can be reported in the "Random Selection" section.
How to minimize the impact of an audit
The checks associated with the 1099 are the easiest to avoid. This can be avoided entirely if you correctly report the amounts shown on Form 1099 on your tax return. Summons triggered audits are out of your control, so unfortunately there's nothing you can do about it If you choose to take legal action, be sure to keep proper records of your cryptocurrency transactions and profit and loss accounts so you can properly protect yourself. Finally, you can work with an experienced tax advisor and have your return professionally prepared to reduce the risk of an accidental audit.
Next step
- Collect all 1,099 forms and list them correctly on your tax return.
- If you have a big profit (or loss) tax year, work with an experienced tax advisor.