Are you among the 10,000 U.S. taxpayers who received the Tax Notice Letters from the IRS about your cryptocurrency transactions?
It is quite intimidating to receive any correspondence from the IRS, especially the one that says take immediate action or!
IRS systems send out automated tax notices more often than you know. As long as the taxpayers take appropriate action in responding to these notices, they can be resolved. The trouble comes when you get to them late or ignore the notices completely.
I don’t believe I have a tax event, so why did I receive a crypto tax notice?
If you think tax event only occurs on the sale of virtual currency, think again. All of the following transactions trigger a tax event:
- Exchanging one cryptocurrency for another (for example: Bitcoin for Ether)
- Receiving Hardforks for holding certain cryptocurrencies (for example: Receiving Bitcoin Cash for holding Bitcoin)
- Receiving wages in cryptocurrency triggers a tax event
- Receiving payment for goods and/or services in cryptocurrency
- Paid for goods and/or services with cryptocurrency
- Received rental income, royalties, partnership income or any other type of passive income in the form of cryptocurrency
- Receiving cryptocurrency through Airdrops
Any one of these transactions would have resulted in a tax event that needs to be reported to the IRS on the specified forms.
What’s in the notice?
The IRS has sent one of the three types of letters to taxpayers, depending on the information IRS has on the taxpayer. These Notice letters are:
Before you start panicking, let’s look at each of these letters and what they say.
Letter 6174 is the least intimidating of the three letters.
If you have dabbled with cryptocurrency transactions between 2013 through 2017 through an exchange, even though you may not have a tax event.
Letter 6174 starts off with this paragraph:
“We 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, which include cryptocurrency and non-crypto virtual currencies.”
Then the notice explains the obligation to report virtual currency transactions and the specified schedules and forms on which these transactions need to be reported.
If you have no crypto transactions other than mere purchase – then this notice can be considered informational. Before you celebrate, re-read the list of transactions above to confirm if you have triggered a tax event in the relevant tax years.
Letter 6174-A is similar to 6174 except for this note
The difference between Letter 6174 and 6174-A is this note: “Note, however, we may send other correspondence about potential enforcement activity in the future.”
IRS not only suspects that you may have crypto transactions that need to be reported, but they are keeping their options open to come back to you when they have enough evidence to prove that you did indeed have crypto tax transactions that needed to be disclosed.
Go back to the respective tax years and see if you have to report any crypto tax transactions. If you end up amending your prior year tax returns, ensure to write “Letter 6174-A” on the top of your amended tax returns as indicated on the notice.
Letter 6173, the deadliest of the three
IRS issues Letter 6173 when they know with certainty that you have had crypto transactions between 2013 through 2017 that were not reported on your tax returns.
This note in the letter indicates that IRS believes you have not filed your tax returns correctly: “For one or more of the tax years 2013 through 2017, we haven’t received either a federal income tax return or an applicable form or schedule reporting your virtual currency transactions.”
What to do if you have received IRS Letter 6173
Luckily, the notice letter itself explains what needs to be done.
“If you failed to file one or more income tax returns, file the delinquent returns and report your virtual currency transactions as soon as possible.”
This applies to taxpayers who have not filed tax returns for the relevant tax years.
“If you made a mistake on your income tax return, such as not reporting your virtual currency transactions or incorrectly calculating your income, gain, or loss; you can file an amended return.”
You have filed the tax returns but failed to disclose your virtual transactions (in full or partial).
“If you believe you followed all tax and information reporting requirements relating to your virtual currency accounts, mail or eFax the following to the address or eFax number shown at the top of this letter.
A statement of facts explaining your position. Include a complete history of previously reported income from your virtual currency transactions. Explain the actions you took to become compliant with U.S. reporting requirements and provide copies of previously filed documents that confirm your compliance.”
If you are among the tax-savvy, and you have reported all transactions, you will have to gather the data (like transaction details from the exchanges), schedules from the tax returns that support your position. Include a cover letter stating the steps you have taken to capture your crypto tax transactions and how you reported them on your tax returns. You can either mail or fax to the IRS. And wait for the IRS to come back.
Be sure to respond by the due date
IRS will provide you with a due date in the tax notice. Be sure to respond to the notice within this time frame. If you fail to comply, IRS may proceed to issue a levy notice or seizure of financial assets (including garnishment of wages).
Be proactive about the interest and penalties
If you did indeed missed reporting certain crypto tax transactions, then the additional tax you calculate while amending the tax returns will trigger interest and penalties. Certain interest and penalties cannot be abated.
However, you may be able to ask the IRS to abate the penalties associated with negligence (which are assessed when the taxes increase by $5,000 or more because of your amending or revising the tax returns). If your taxes have increased by $5,000 or more, you want to attach a letter explaining why your transactions were not reported earlier and ask IRS to abate the penalties associated with negligence. The abatement is at the discretion of the IRS.
Do not forget the State taxes
Is your head spinning yet? If not, think about State taxes. Unless you happen to live in the States where there are no income taxes (Texas for example) – you have to amend your State income tax returns along with Federal, even if you have not received any tax notices or requests from the respective state.
Do not forget FinCEN Form 114
If you held your crypto assets in foreign exchange or foreign financial institution, you might have triggered FinCEN Form 114 disclosure requirements. Failure to comply with FinCEN regulations may transpire into a criminal offense. If you are unclear about whether or not you have FinCEN Filing, read this simple guide.
Do I need a crypto tax advisor?
The answer to that question really depends on your situation. If you did indeed have crypto tax transactions that were not reported – you have to think about the Federal, State, FinCEN filings and whether you have the know-how to do it.
If you are going about this on your own, check out the article on Comparing the Best Crypto Tax Software.
If you are looking to hire a crypto tax advisor, read our article on “How to pick the right Crypto Tax Advisor?”
Do not forget to check out our article on “Top 5 Best Practices for Filing Crypto Tax Returns.”
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About the author
RK Reddy holds two Masters degrees, one in Accounting and another in Business Administration with over 15 years of experience in the financial services industry.
Read more about the author here.