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IRS Crypto tax AUDIT notice probes deep – Key Takeaways & next steps

IRS TAX Form

What you can expect in this article?

  • Deeper look at the IRS Crypto Tax Audit notice letter
  • Key takeaways from this audit notice you need to know
  • Why this notice shows lack of IRS’s awareness about crypto space
  • Next steps if you have received the IRS Crypto Tax Audit notice
  • Will you need representation if you received this IRS Crypto Tax Audit notice?
  • Is using Crypto tax software catch all strategy?

An IRS Crypto tax audit notice has been circulating on Reddit. Originally posted by user Ubuntaire titled “Anyone wants to see what an IRS audit notice looks like?” has been making waves on social media.

If this is a genuine tax audit notice, the kind of detail that IRS seeks is pretty far reaching. Some of the Redditors have commented on this audit to be a ‘colonoscopy’ and ‘probe’.  

The crypto tax audit notice page posted on Reddit has been replicated below.

_________________________________________________________________________

Below is the text format of the IRS Notice, find the original here.

To make Examination as brief as possible, please have the following information available: 

  • A copy of your 2017 tax return

Provide the following for all virtual currency transactions during the time period 01/01/2017-12/31/2017

  • Detailed records for the acquisition and disposition of any virtual currency (domestic or international), including but not limited to:

o   Emails, screen prints, hardcopy prints, and transaction receipts maintained by the taxpayer or provided by any third-party such as an exchange, broker, or peer-to-peer facilitator (e.g. Paxful, Localbitcoins.com)

o   Wire transfer or direct deposit records, including automated clearing house (ACH) and electronic funds transfer (EFT) records.

o   List of all virtual currency kiosk (i.e., BTM or cryptocurrency kiosk or ATM) locations used along with copies of any transaction receipts or acknowledgements whether provided electronically or in paper.

o   A detailed list of cryptocurrency transactions involving cash including dates, input/output counterparties involved in the transaction, and the cryptocurrency involved

o   All correspondence (I.e., emails, texts, tweets, etc.) with all counterparties to any virtual currency transactions

o   List of all virtual currency received from hard forks, faucets, tipping, or any other method where a sale, buy, or exchange was not initiated by the receiver of cryptocurrency (commonly called airdrops), including date, type, and amount of virtual currency received with the date of sale, or other disposition, including amounts and description of what was received

o   Explanation of the method used to compute basis relating to the sale or other disposition of virtual currency

o   Records reflecting the valuation of any sale or other disposition of virtual currency at the time of acquisition and disposition

  • Records relating to any expenses paid or items purchased (whether domestic or international) using virtual currency
  • List of all blockchain addresses owned or controlled by taxpayer
  • Records of all transactions relating to lending of virtual currency or use of virtual currency as collateral for loan, including, but not limited to, loan agreements, promissory notes, ledgers, transaction receipts, pledge, security, or collateralization agreements
  • List of all digital currency exchanges (DCE) and peer-to-peer (P2P) facilitators (e.g., Coinbase, Paxful or Localbitcoins.com) (foreign and domestic) with associated user Ids, email addresses, IP addresses, and account numbers relating to those platforms
  • List of all counterparties for any P2P virtual currency transactions (identifying the on-chain and off-chain transactions), email address, user IDs transactions.

This is not an all-inclusive list. Requests for additional information may be made if considered necessary. 

_______________________________________________________________________

Key takeaways from the IRS Crypto Tax Audit notice

IRS seems to be coming hard and mighty at the folks who have either ignored to report their cryptocurrency taxes or have not reported everything. This particular IRS Crypto Tax Audit notice pertains to 2017 tax year. Let’s look at some of the key takeaways from this notice.

Emails and correspondence requested

  • IRS is asking for emails, hard copy prints, transaction receipts to substantiate the information provided by you on your tax returns. If you have knowingly ignored to disclose your crypto transactions – then IRS seems to know exactly how to get your information.

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Airdrops, Hardforks, faucets and tipping

  • Probably one of the trickiest and most difficult of all the requests on this notice is the information about Airdrops, Hardforks, faucets and tipping information. Forget about the users keeping track of this information, it is unclear as to how IRS is going to track this information since most of the airdrops and faucet drops are probably worth nothing and they may have been long forgotten because they were worth nothing.

Even if they were worth something, it is quite difficult (or even impossible) for individuals to keep track of the number of places one would have given their wallet address to receive something.

List of blockchain addresses owned

  • Creating wallet addresses is free and happens in seconds.  As such, many people would have created numerous addresses on various wallets and may have never used them. As such, it is unclear why the IRS would simply ask for ALL blockchain addresses ‘controlled’ by taxpayers, instead of saying ‘blockchain addresses controlled by taxpayer with any crypto transactions’.

All in all, the language is designed to be all inclusive and being a relatively new technology – IRS covered all the known basis where a transaction history might live.

Why this notice shows lack of IRS’s awareness about crypto space?

The request shows the shortage of understanding on the IRS’s side as to how the airdrops and other rewards work.  We think a think tank and revisit on certain aspects of Crypto space is required from the IRS side to develop a practical framework:

  • Set de minimis to report airdrops and rewards
  • For the projects that go bust or out of business should be exempt from reporting 
  • Proposal to Assume ‘0’ as cost basis and have reporting mandated on “sale” rather than receipt
  • Open up a public access to track wallet address based transactions so that people can reconcile what they have/remember with IRS records, this will help honest taxpayers who may otherwise inadvertently miss certain transactions

Those are our thoughts on what needs to change to make these reporting requirements more sensible for an average taxpayer with average technical sophistication.

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Next steps if you have received the IRS Crypto Tax Audit notice

Here are few things you should do, in our opinion:

  • Put together the documents substantiating what has been reported on the tax returns
  • Scour through all of your wallets and check the transactions in the relevant tax year
  • Create a checklist (ideally in a spreadsheet) to track all of your wallets and related transactions
  • Print out any emails, correspondence and other transaction details, and arrange them in order of occurrence (date) 
  • Check to see if you can hire a Crypto Tax Advisor.  Here are the key things you need to look in a crypto tax advisor
  • In some cases, depending on the seriousness, you might need a tax attorney to represent you to avoid complications

Is representation required if you receive this IRS Crypto Tax Audit Notice?

It is unclear as to what happens if you are unable to track down your emails or just don’t have the information about your airdrops, hard forks, faucets and tipping details.  What if you have long forgotten or do not have access to those wallets anymore?  

Will the IRS subpoena your emails and electronic communication?

Will the IRS subpoena your bank accounts and credit card accounts?

How long will this IRS Crypto Tax Audit take to resolve?

What implications will it have on your future taxes?

Given these and other questions that we have not yet thought of to ask, in our opinion, we think it would help to have proper legal representation when dealing with this IRS Crypto Tax Audit notice.

Is using Crypto tax software ‘catch all’ strategy?

If you have used crypto tax software, it might help you document your ‘best efforts’ in reporting the crypto transactions for taxes, however, it is not a panacea to your tax woes.  

For starters, crypto tax software only picks up the transactions that you link through an API.  Most crypto tax software do not pick transactions that happen from wallet to wallet outside the exchange.

If you have used the Best Crypto Tax Software and connected all of your exchanges and do not have transactions outside of these exchanges, chances are, you may not get the IRS Crypto tax notice at all.

The fact that one has received the IRS Audit notice might indicate that you have either ignored to report certain transactions or have not reported them at all.

Either way, go back and check all of your crypto transactions, keep the documentation ready.

Best Crypto tax Software

Do NOT underestimate IRS’s ability or outreach

Even when we were mocked for suggesting to report All of your crypto transactions on your tax returns, we continued to maintain our stand.  

All those social media trolls are not going to come to your rescue when IRS knocks on your door.  

If you are among those who received this IRS Crypto Tax Audit Notice, do not ignore it thinking that IRS will not have the know-how or outreach, because, both of those assumptions could lead to your peril.  

We don’t mean to sound apocalyptic about these affairs and our genuine hope is to encourage you to take the right action as per the law.  Whether that is using a representation or doing it on your own is your choice as long as you do not simply throw this IRS Crypto Tax Audit Notice in the dustbin. 

Immediate tax article references that might be of interest to you:

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IMPORTANT DISCLAIMER

Everything in this article is an opinion, not an advice of any kind. This material has been prepared for general informational purposes only and it is not intended to be relied upon as accounting, tax, investment, legal or other professional advice. Please consult with a professional for specific advice.

We do not endorse or guarantee the accuracy of the information and claims made.

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