Most of us despise tax season, but the added complication of having to file cryptocurrency returns in 2023 can make it even messier. Reports show that in 2018, less than 0.4% of Americans reported their cryptocurrency gains to the IRS. At the time, roughly 7% of Americans were estimated to own Bitcoin or other cryptocurrencies. Since then the number of people who own cryptocurrencies has jumped significantly. Currently, 17% of Americans report having used or owned cryptocurrencies.
Crypto Tax Reporting
Cryptocurrency tax reporting is still lagging. Because of this, the IRS is cracking down on cryptocurrency holders. Previously the IRS cryptocurrency guidance was somewhat slow to keep up with the digital asset class. Now, however, the tax laws on crypto are firmly set in place, and the IRS is taking a less lenient approach to non-disclosure of cryptocurrency assets and earnings. The tax laws surrounding crypto are under constant revision, meaning it can be difficult to know the implications of investing in the space. If you bought, sold, mined virtual currency like Bitcoin or ran a cryptocurrency business in 2022 or before, you will most likely owe taxes.
The Internal Revenue Service (IRS) is shifting attention to cryptocurrency now that it has become more mainstream, and has begun aggressively policing possible attempts to evade virtual currency taxes. Some of these taxpayers may not actually be trying to evade the IRS, but might simply make mistakes that could cost them big.
This is leading many holders to wonder if they will automatically get audited by the IRS this tax season, and what will happen if they do. Are you worried about a potential audit from the IRS into your crypto holdings? If so, you’ll be happy to know there are a number of steps you can take to reduce the chance of this.
Continue reading to find out what the chances are of getting audited this year, what qualifies as a taxable crypto event, how to reduce them, how to properly file, and what to do if the IRS does decide to audit you.
The IRS Is Intensifying Its Focus on Cryptocurrency Holders
If you are worried about an IRS crypto audit this year, your fears might not be unfounded.
Like we mentioned above, the IRS is intensifying its focus on cryptocurrency holders. There are two reasons for this. Firstly, crypto holders have a historical track record of either under-reporting or entirely omitting to report their digital asset earnings.
Operation Hidden Treasure
The private nature of cryptocurrencies also lends itself to money laundering activities. Because of this, the IRS has launched its Operation Hidden Treasure.
IRS Operation Hidden Treasure is an initiative by the Internal Revenue Service (IRS) to encourage people to voluntarily disclose offshore assets and income that they have not properly reported on their tax returns.
Some key facts about Operation Hidden Treasure:
– It was launched in March 2009 to get taxpayers to disclose foreign accounts and assets that they had previously hidden from the IRS.
– The goal was to bring in tax revenue from non-compliant taxpayers with offshore holdings and promote voluntary disclosure.
– People who truthfully disclosed their offshore assets before the initiative’s deadline could avoid criminal prosecution and steep penalties.
– After the deadline, penalties and enforcement were increased substantially on undisclosed foreign accounts and entities.
– By coming forward voluntarily, people could mitigate penalties, avoid jail time for criminal tax evasion, and set up repayment plans.
– The initiative expired on October 15, 2009 after bringing in over 3,000 voluntary disclosures.
– It offered incentives for taxpayers to get compliant before stricter foreign asset reporting rules took effect and enforcement ramped up.
– It was a push to crack down on tax haven abuses and offshore tax evasion by US taxpayers.
The IRS crackdown on digital currencies isn’t all that new, having started a few years ago.
In 2019 the IRS sent out 10,000 letters to taxpayers with crypto transactions in their names who didn’t report them. In 2020, the IRS once again warned crypto investors of under-reported gains.
Come 2023, and the IRS is now shifting its approach to crypto tax from education to enforcement.
How to Know if You Owe Cryptocurrency Taxes
The million-dollar question is this: Will you owe taxes on cryptocurrency? The IRS’ definition of property states that property extends to items purchased with digital currency. This means purchases involving cryptocurrency are subject to the same taxes as anything else you buy or sell.
The IRS has been reminding taxpayers for the past few years that taxes must be paid on virtual currency transactions. That includes warning letters that were sent to more than 10,000 American cryptocurrency owners in 2019.
A draft of the 2023 1040 U.S. Individual Income Tax Return opens with a reminder that all tax filers must declare whether they’ve sold, received, exchanged, or acquired any cryptocurrencies. This question was also on the 2019 income tax form, but only on Schedule 1, the form used to declare “Additional Income and Adjustments to Income.”
7 Ways to Track Crypto Taxes
|1. Cryptocurrency Tax Software||CoinTracker, CryptoTrader.Tax, TokenTax||Platforms that integrate with exchanges and wallets to auto-track transactions and generate tax reports.|
|2. Portfolio Tracking Apps||CoinMarketCap, Delta, Blockfolio||Apps that allow manual tracking of crypto holdings across different exchanges to calculate gains/losses.|
|3. Spreadsheets||Excel, Google Sheets||Can be used to manually log and calculate crypto transactions, gains, losses, and income.|
|4. Blockchain Analysis Tools||Blockseer, Blockchain.com||Platforms that can track wallet transactions on public blockchains to assess tax implications.|
|5. Tax Prep Services||CPAs, Tax Pros||Some utilize in-house crypto tax software and services to manage client crypto taxes.|
|6. Exchange Tax Forms||Coinbase||Exchanges issue 1099-MISC, 1099-K, and other tax forms reporting crypto income and sales.|
|7. Record-Keeping||Receipts, Transaction Logs, Exchange Records, Wallet Data, Basis Documentation||Carefully maintaining these records is critical for tax tracking and reporting.|
Using the right crypto tax tools can save significant time and effort compared to manual methods. But proper documentation is still essential when dealing with such a complex emerging asset class for taxes.
What the New IRS Cryptocurrency Guidance Says
Although the IRS is taking a stricter stance to non-reporting of crypto gains, IRS cryptocurrency guidance remains roughly the same for this year.
However, there are one or two changes. One new piece of IRS crypto guidance is that the Treasury requires any transfer worth $10,000 or more to be reported to the IRS.
This piece of internal revenue service cryptocurrency guidance means that the IRS will have access to more information on crypto-related trades and transfers.
Another new development this year is the inclusion of a yes/no question regarding crypto assets on the first page of taxpayer returns.
If you answer “no” to this question, while having transacted in crypto during the year, there is a very good chance the IRS is going to investigate your return.
What Are and Are Not Taxable Cryptocurrency Transactions?
The 2019 warning letters drew calls for greater clarification and guidelines on taxing crypto activity, but that hasn’t stopped the IRS from charging ahead with audits. The new, more direct guidance of the 2020 1040 draft shows how seriously the IRS is about taxing cryptocurrency transactions.
All cryptocurrencies are taxable, but are all the transactions made with them taxable? Here are four examples of taxable cryptocurrency transactions:
What is not considered a taxable transaction?
What Are the Chances of Being Audited?
Given the increased focus on cryptocurrency gains and the new IRS cryptocurrency guidance, you might be wondering what’s the chances of getting audited this year.
The odds of being audited for cryptocurrency taxes specifically are still relatively low, but increasing as crypto use grows. Here are some key points on crypto tax audit odds:
– Overall individual audit rate is around 0.6% – 1% per year according to IRS data.
– However, crypto holders are estimated to have an audit rate of around 2% – 5%, higher than average.
– The more activity/transactions with crypto, the higher audit risk seems to be based on professional estimates.
– Crypto tax non-compliance is estimated at over 50% by some experts, which drives greater IRS scrutiny.
– New IRS question about virtual currency on Form 1040 increases visibility into potential crypto tax issues.
– Amended return filings related to crypto are said to often trigger IRS notice letters or inquiries.
– Discrepancies between trading platform 1099 forms and taxpayer filings can also raise audit risk if not addressed properly.
– Audit risk is higher for very large crypto holdings with potential for significant tax underpayment.
So while the overall odds are still relatively low, taxpayers with crypto should take care to fully comply with tax obligations to minimize audit chances. Consulting a tax professional knowledgeable in crypto can help assess any specific risks. Taking the right steps can give confidence in handling a potential audit.
Also, it does seem like owning or transacting in crypto can heighten the chances of an audit from the IRS. If you fail to thoroughly report your transactions and gains, there is an even larger chance of an audit.
However, this doesn’t mean that you’ll automatically get an IRS audit on your tax return just because you have a crypto investment. If you accurately report your gains and losses, you might be able to ride out the tax season audit-free.
Worried about an IRS crypto tax audit?
Don’t risk fines or worse – call our tax law firm for urgent assistance with your crypto tax audit today!
A Note On What To Do If You Get Audited
No matter how careful you are, there is always a chance of an IRS audit. If you do end up receiving a crypto tax audit from the IRS, here’s what to do:
- The first thing to do if you receive an audit notice is to stay calm. Just about any communication from the IRS can be stress-inducing for most people. Getting audited sounds like a scary process, but if you have fulfilled your reporting duty fully, then it’s just a matter of cooperating with the IRS until they are satisfied.
Comply with information requests. If you have received a CP2501 Notice it is important that you comply with all the information requests as quickly as possible. The IRS gives taxpayers 30 days to respond to a CP2501 Notice. If you do not respond within this window period, the IRS will send another letter with their proposed changes to your return and any extra taxes or fees you will need to pay as a result.
If you need immediate help with the audit process (or any other area), we provide emergency tax services.
Don’t speak about mistakes or omissions directly with an IRS agent. After receiving an audit letter, it is very important that you don’t speak about any mistakes or commissions you might have made on your return to an IRS agent. If the IRS suspects you of tax evasion, they can use these agent communications as evidence against you.
You also shouldn’t talk about these with your accountant, as the IRS can use them as a witness against you. If you have made any tax errors or omissions in regards to your crypto gains, it is best to seek the advice of qualified tax attorneys instead. They will be under no obligation to supply the IRS with any evidence against you, and can legally protect your interests.
Question inaccurate audit results. If the IRS is proposing changes to your return that are in error, you should contest these. Just because the IRS has proposed changes doesn’t mean you have to accept them.
If there are errors, you should contact the entity that provided the false information (such as an exchange) and request they rectify what they reported.
From here you can then follow the instructions on the CP2501 Notice for incorrect information.
Speak with a tax expert. If you are facing an IRS crypto audit, one of the most advantageous things you can do is to hire a qualified tax attorney.
If your case is involved, the best people to work with is a group of experienced tax attorneys. They will be able to handle the audit process professionally and seamlessly and give you confidential audit advice and assistance.
If you need to speak to a team of qualified tax attorneys, Silver Tax Group can help. One of our areas of service is IRS audit defense.
How to Reduce the Likelihood of an IRS Audit
Although there might be a higher chance of getting audited if you hold crypto, there are also steps you can take to avoid a cryptocurrency audit by the IRS. Even if these measures don’t prevent an audit, they will help ensure that if you do get audited it will be a simple process.
Document all of your trades. No matter whether you purchased crypto, or received it as a salary or a payment, you will need to document every transaction.
If you receive crypto as a salary, you will need to note down its dollar value at the date you received it. If you purchase crypto, you’ll need to have a record of its dollar value when you bought it.
When you sell or exchange cryptocurrency, you must deduct its base cost (its dollar value when you bought it) from the sale amount. The amount you make on the sale will be your capital gain.
This same applies to crypto you earned as regular income. For instance, if you receive your salary in cryptocurrency, you must work out any gain or loss you incur when you sell it for fiat currency.
How Cryptocurrencies Are Taxed
The first step to take if you’re worried about an IRS crypto audit is to gain a basic understanding of how cryptocurrencies are taxed. While this in itself won’t prevent an audit, it will help you to complete your tax return accurately.
The IRS cryptocurrency guidance on taxable crypto events is too involved to outline here in its entirety. However, the basics of crypto tax is fairly simple.
To start with, most crypto gains are taxed at either:
In other words, if you buy Bitcoin and sell your position after 6 months, any profit you make on the trade will fall as short-term capital gains and attract the same tax rate as your income tax bracket. On the other hand, if you hold the Bitcoin for more than 1 year and then sell, the tax rate on any profit will be the long-term capital gain rate, which is currently 20%.
There are also some situations where cryptocurrencies are taxed as regular income. These include:
Accurately report all your crypto gains and income. If you have kept a record of all your transactions, this makes things a lot simpler.
If you haven’t, you will need to comb through your exchange records and work out your capital gains. When reporting capital gains and crypto income, make sure you don’t forget about things like hard forks, mining, and staking income.
If you want to learn more about the IRS cryptocurrency guidance and reporting requirements, check out this article of ours on how to report crypto capital gains.
How to File an Audit-Proof Cryptocurrency Tax Return
Well, there’s no real audit-proof tax returns. But filing honestly and with the help of a professional is as audit-proof as you can get as filing taxes has become even more complex over the past few years and adding cryptocurrency to the mix isn’t making it any simpler.
Here are four steps you can take to help avoid a cryptocurrency audit.
- Report all of your income, including capital gains, mining income, staking income, and anything else.
- File the mandatory anti-money laundering forms (FBAR and 8938). If you don’t, it could result in huge fines!
- Claim all past losses on things like Ponzi schemes, scams, and lost/stolen wallets.
- File a disclosure statement. This makes sure an auditor isn’t allowed to seek certain penalties.
You’re risking a cryptocurrency audit if you fail to properly file your crypto return. The IRS can request copies of all emails, third party transaction receipts, wired transfers, a list of virtual currencies received, and the list goes on. It is also very important to do it right and avoid these common mistakes people make when filing crypto taxes.
3 Common Mistakes People Make When Filing Cryptocurrency Taxes
There are three main mistakes people make when filing crypto returns:
1. Not Filing the Mandatory Anti-Money Laundering Forms FBAR and 8938
The IRS is serious about clamping down on money laundering activity, and it’s actually a big reason they are so focused on cryptocurrency taxation and auditing. These anti-money laundering forms need to be filed for every foreign account you hold or you could get a $10,000 fine per account, per year.
2. Not Reporting Like-Kind Exchanges
These are crypto-to-crypto exchange transactions, and they are easy to forget to report. It is not enough to report gains; you must report everything.
Another thing you shouldn’t do is speak directly to an IRS agent about any filing mistakes or omissions. Anything you say to a federal agent can and will be used against you in an audit. Always contact an experienced tax professional if you have questions. The landscape of finance has changed with the introduction of cryptocurrency, so remember these tips when filing a return.
3. Not Reporting Purchases Made With Cryptocurrencies
Another thing not to forget about when reporting your crypto gains is any purchases you make using cryptocurrencies. The current IRS cryptocurrency guidance stipulates that purchases made with crypto are taxable events.
For instance, let’s say you bought Ethereum on October 23, 2021, when the price was $3,990.71. The next day you used some of your Ethereum to purchase a coffee.
In the time between when you bought the Ethereum and when you used it to pay for your coffee, the value increased to $4,074.86 per token.
When you bought your coffee, you will have realized a small gain on the Ethereum you used for the purchase. IRS crypto guidance requires you to report these capital gains.
Therefore, if you want to ward off an IRS crypto audit, make sure you keep track of your purchases using crypto and report any gains or losses realized on these.
File Any Required Anti-money Laundering Forms
If you own a business and receive a crypto transaction worth more than $10,000, you must also file Form 8300 with the IRS. This anti-money laundering form used to only be required for fiat transactions.
However, under the new IRS cryptocurrency guidance business owners must now submit the form for cryptocurrency payments as well.
Get Expert Help Filing Cryptocurrency Taxes
If you wondering whether you’re going to receive an IRS crypto audit—there isn’t any way to know for certain. However, there can be a heightened chance of experiencing an audit if you engaged in crypto transactions.
The key to avoiding an audit is to accurately report your gains and earnings.
Unfortunately, the IRS cryptocurrency guidance and requirements are somewhat involved when it comes to cryptocurrencies. If you feel daunted by the process of accurately reporting your holdings, gains, and income, we can help.
There are a lot of things to remember when filing a cryptocurrency tax return. You will most likely owe taxes if you own any type of virtual currency. The last thing you want is a cryptocurrency audit if you fail to properly report. It can be a complicated process, but with the right tax attorney, you won’t have to worry about a thing.
To reduce your chances of an IRS crypto audit you should seek out professional tax compliance advice.
Accurately reporting cryptocurrency gains and income can be an involved task, thanks to the current IRS cryptocurrency guidance and tax rules. What’s more, the IRS is becoming less lenient around the under-reporting of crypto gains.
Here at Silver Tax Group, we offer professional IRS tax consulting. Our experienced tax attorneys provide full-service tax compliance guidance.