The IRS issued a summons demanding that Coinbase produce a wide range of records relating to its customers in December 2016. After a legal battle, the crypto exchange turned over the records of 13,000 customers that rarely reported taxable gains. The move underscored the extent of tax evasion in crypto and prompted the IRS to take an increasingly hostile stance.
Let’s take a look at how the IRS has targeted crypto traders and investors in the past and evidence that it’s stepping up efforts in 2020 and beyond.The IRS has gradually stepped up its crypto enforcement over the past five years, moving from warning letters to private contractors to assist in uncovering tax evasion. Click To Tweet
Warning Letters & Changes
The IRS sent over 10,000 letters to crypto investors suspected of improperly reporting or failing to report transactions in July 2019. Around the same time of the following year, the agency sent thousands more letters reminding taxpayers of their obligation to report crypto transactions or requiring them to submit additional information to avoid an audit.
Sample of IRS Warning Letter – Source: IRS
There are three types of letters:
- Letter 6173 requires taxpayers to file delinquent returns, correct past returns or demonstrate compliance in a signed statement with a due date.
- Letter 6174 informs taxpayers of the requirements for reporting virtual currency transactions but doesn’t make any direct accusations of misconduct.
- Letter 6174-A suggests that taxpayers may have not properly recorded transactions and requests that any necessary updates be made to account for them.
The new round of letters come after the IRS released updated guidance in October 2019 that elaborated on the tax treatment of forks, air drops and other ambiguous cases. In addition, the IRS posted a lengthy list of frequently asked questions for taxpayers and accountants to better understand its rules and regulations surrounding crypto markets.
In December 2019, the IRS introduced Schedule 1 to Form 1040, which requires all taxpayers to declare any crypto activity. The new question makes it possible for the IRS to criminally prosecute anyone who willingly answered the question untruthfully. In other words, it has become a lot more difficult to claim ignorance in failing to account for the transactions.
Gearing Up for Enforcement
The IRS began hiring outside contractors in 2020 to help identify crypto traders and investors whose tax returns either omit or contain inaccurate transactions. In a letter sent to some crypto tax experts, the agency said that it is placing a few single-case contracts as pilots with the goal of publishing a solicitation and request for proposal for a large multi-case contract.
In particular, contractors would work off of public on-chain data and private off-chain data to try and determine if taxpayers underreported their crypto gains. These efforts mark a significant expansion from the warning letters that the agency has been sending to taxpayers thus far and the limited number of audits seen in the community.
How to Avoid Problems
You can avoid problems with the IRS by ensuring that you accurately record crypto transactions. While it can be challenging to reconcile transactions across wallets and exchanges by hand, crypto tax software can streamline and automate the process. It’s the easiest way to ensure that everything is accurate each year and you have a defensible paper trail in place.
ZenLedger’s Pre-filled Tax Forms – Source: ZenLedger
For example, ZenLedger makes it easy to aggregate transactions across wallets and exchanges, compute capital gains or losses and auto-populate tax forms for your accountant. In addition, you can use the tax loss harvesting tool to identify opportunities to reduce your tax bill throughout the month by selling losing positions to realize the loss and offset other income.
There are a few things to keep in mind when choosing a crypto tax solution:
- Audit Trail: The crypto tax software should provide a transparent audit trail that you can use in the event of an audit in order to prove that you accurately recorded transactions.
- Complex Transactions: DeFi, staking, margin trading and other complex transactions may not be possible with every crypto tax solution.
- Integrations: TurboTax or other software users may want to consider crypto tax options that integrate with their tax prep solutions to simplify tax season.
- Tax Loss Harvesting: The best solutions enable you to save money on taxes via tax loss harvesting rather than just helping you pay the right amounts.
If you have unrecorded transactions, you may need to file a delinquent or amended tax return for prior years. These actions may trigger a tax liability in the current year but leaving taxes unpaid could result in a much larger future liability. The statute of limitations doesn’t apply for fraudulent transactions (e.g. intentionally not reporting transactions).
ZenLedger offers a full-service solution for crypto traders and investors that want hands-on help from an experienced accountant. These plans range from $750 for <50 transactions, up to $50,000 in total value and up to four tax returns to $2,500 for active traders that have up to $1 million in crypto assets and require several different tax forms.
The Bottom Line
The IRS has gradually stepped up its enforcement efforts over the past five years. While warning letters have been common over the past two years, there are signs that the agency is gearing up to enforce tax laws in 2020 and 2021 with the solicitation of private contractors experienced with blockchain analysis.
If you want to ensure your taxes are accurate, ZenLedger can help you quickly aggregate transactions, compute gains and losses, and even pre-fill popular IRS forms to make it as easy as possible for you and your accountant.