The U.S. Internal Revenue Service (IRS) has started sending out new letters to cryptocurrency owners suspected of owing crypto-related taxes. A tax expert has shared with news.Bitcoin.com what crypto owners should know, including how to handle tax letters from the IRS and avoid an audit.
How to Deal With IRS Letters
The IRS has ramped up its efforts to ensure that cryptocurrency owners pay all crypto-related taxes. It has begun sending out a new round of tax letters similar to the ones sent to about 10,000 crypto owners last year. There are three types of letters, referred to as Letters 6173, 6174, and 6174-A. In addition, the IRS recently moved the cryptocurrency question from Schedule 1 to the top of Form 1040, the main form used by about 150 million people to file their taxes.
Clinton Donnelly, the founder of Donnelly Tax Law, has helped over 12,000 crypto owners with their tax returns, avoiding over $40 million in gains by using like-kind exchange calculations. He has shared some insights with news.Bitcoin.com to help crypto owners deal with the IRS, its crypto question, and tax letters.
BC (Bitcoin.com): What are the differences between the three IRS letters, and how should cryptocurrency owners react to each of them?
CD (Clinton Donnelly): Letters 6174 and 6174A are similar. They advise the taxpayer to double-check that they reported all their income. Letter 6174A goes into a little bit more detail.
Letter 6173 differs by requesting that the taxpayer submit a signed statement if they don’t amend their returns. This statement reads: “I declare under penalties of perjury that I have examined this entire document, including all attachments and accompanying statements, and that the enclosed is true, correct, and complete.” Perjury is the intentional act of swearing a false oath. The sentence is one year in prison and or fines. The wording of this oath is the same as on the Form 1040 when you sign.
Additionally, Letter 6173 is the letter sent to taxpayers suspected of engaging in criminal tax evasion. If you get this letter, you should be concerned.
Receiving this letter means that the IRS has evidence suggesting criminal wrong-doing. Ultimately, it would be best if you contracted with a tax attorney experienced in criminal tax cases. This attorney should employ a top-notch crypto tax audit specialist to do the crypto aspects under the protection of a Koval letter that extends attorney-client privilege to the tax audit team’s work.
BC: What should cryptocurrency owners do if they receive a tax letter from the IRS?
CD: You should contact a tax professional specializing in crypto audits. It would be best if you talked to someone who understands the audit process and how the IRS is treating crypto income in audits. He/she would be the best person from whom to gain your knowledge.
If you receive a letter, it is crucial to understand that you are now on the IRS’ audit radar. That means your odds of being audited are significant.
Remember, an auditor’s job is to find mistakes in your return. It can be expensive to defend yourself against the IRS because audits often take a year and a half to resolve. This stress can take a heavy toll on letter recipients.
Anyone not experienced in crypto audits will make a poor advisor if you’ve received a letter. It’s essential to ask your advisor if they have experience in crypto audits.
BC: Can you elaborate on the crypto holding threshold of taxpayers who got an IRS letter last year versus this year?
CD: I had a couple of dozen clients who got the 2019 letters. These recipients had in common that they all had a crypto portfolio valued at over $900,000 or more in 2017.
It is a mystery how the IRS determined these recipients. Some of them never used U.S. exchanges, yet the IRS was aware that they were whales.
The recipients of the 2020 letters have maximum portfolio balances in 2017 of only $100,000 or more. They also appear to be recipients of Coinbase 1099 forms.
BC: Are taxpayers with only small crypto holdings likely to receive one of these letters from the IRS? Is there a level of crypto holdings the IRS deems “too small” to send letters about?
CD: Every time the IRS mails out a letter, it generates work for them when the taxpayer responds. They do not have the workforce to send out millions of letters. Also, there are diminishing returns as they pursue smaller taxpayers.
BC: How does the IRS find out about taxpayers’ crypto holdings?
CD: The IRS doesn’t disclose their methods, but we gather clues from what IRS executives say and past methods. They have said that they are using data mining techniques to identify those to examine. An obvious clue is receiving a 1099 tax form from U.S. crypto exchanges. They then correlate those against taxpayers who have words like…
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