Published on: February 16, 2021 Last modified: February 22, 2021

How to Avoid a Cryptocurrency Audit in 2021

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    Most of us despise tax season, but the added complication of having to file cryptocurrency returns in 2021 can make it even messier. 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 mined virtual currency like Bitcoin or ran a cryptocurrency business in 2020, 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 guide will walk you through what qualifies as a taxable cryptocurrency event, how to file a bulletproof tax return to avoid a cryptocurrency audit, and the risks of improperly reporting crypto on your returns.

    avoid cryptocurrency taxes

    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 2020 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.”

    taxable cryptocurrency transactions

    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? 
    These lists are not comprehensive, and there are many other circumstances in which your cryptocurrency transactions may be taxed. You will need to evaluate these transactions with a fine-toothed comb to make sure you’re handling your taxes properly. Hiring a qualified tax attorney would be very helpful if you’ve made a lot of virtual currency transactions.
    cryptocurrency audit reporting

    How to File an Audit-Proof Cryptocurrency Tax Return

    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 avoid a cryptocurrency audit.

    1. Report all of your income, including capital gains, mining income, staking income, and anything else.
    2. File the mandatory anti-money laundering forms (FBAR and 8938). If you don’t, it could result in huge fines!
    3. Claim all past losses on things like Ponzi schemes, scams, and lost/stolen wallets. 
    4. 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. 

    irs notice of deficiency

    Common Mistakes People Make When Filing Cryptocurrency Taxes

    There are two 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.

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    Get Expert Help Filing Cryptocurrency Taxes

    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. 

    Contact Silver Tax Group to speak to a tax expert about avoiding a cryptocurrency audit today. 

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