Those who invest in cryptocurrency, may have to brace themselves for some serious negotiations with the IRS, America’s tax authority. As of last week, the IRS began sending out 10,000 letters to United States-based crypto investors who have yet to report their crypto earnings.
The aim of these letters is to educate cryptocurrency traders on their tax obligations, as well as to encourage them to review their previous tax returns. If necessary, taxpayers in this sector are expected to file amended returns documenting their full crypto activity. Let’s look in more detail at some of the letters you may encounter from the IRS regarding this topic.
IRS Letter 6173 – The One You Must Answer
This particular letter is sent out when the IRS has found adequate evidence of unreported crypto transactions based on the data acquired via enforcement actions. This type of letter is prevalent with Coinbase customers. In March 2018, the digital currency exchange was ordered by the federal court to hand over their database to the IRS. It was a calculated move to get data on crypto owners that engaged in transactions of over $20,000 between 2013-2015. If you have received this letter, the reason could be that you did not file a return with your complete crypto trading history or you missed some critical documents. You should respond to this letter with an amended tax return and all applicable schedules.
IRS Letter 6174 – The One That Means the Law May Be Watching
This type of letter is a soft notice which provides all tax-compliance information in addition to urging taxpayers to review their returns. A key phrase to consider in this letter is that the crypto investor ‘might not have full knowledge’ regarding tax treatment. As such, there is no pressing need to reply to this letter – and the IRS has no intention of following it up either. However, still consider reviewing your previous tax returns and file amended returns if you feel you need to.
IRS Letter 6174-A – The Softest Notice (But Still Worth Paying Attention To!)
The final type, the 6174-A comes as a ‘less’ soft notice. The critical aspect of this particular letter is that you may not have correctly reported your returns. As an example, a crypto taxpayer might have utilized Schedule C, which represents business income, rather than Form 8949, which serves capital gains. If you receive this letter, consider it notice for potential future law enforcement action. However, just like letter 6174, you are not obliged to respond.
As crypto exchanges increasingly become more regulated and share data with the IRS, such letters are likely to continue. It is worth noting that the IRS does not need to send these letters, and could simply jump to a full review of an individual’s account instead. However, such efforts are expensive even for the IRS, so it benefits them more if people have the option to amend their returns.
FATCA Reporting – The New Tax-Evasion Fighter on the Block
The IRS has always maintained that taxpayers who do not file capital gains tax on their cryptocurrency transactions will be subject to penalties, fines and, in some cases, even criminal prosecution. The IRS recently froze brokerage and offshore accounts of investors that had failed to disclose their financial holdings outside the US. One way that the IRS managed this was through FATCA (the Foreign Account Tax Compliance Act). The role of this legislation is to ensure that assets held in foreign accounts are reported by their US account holders. It is not yet clear if FATCA applies to cryptocurrency accounts as well however it is worth noting that the IRS recently clarified that at least the FBAR form (similar to FATCA) does not need to be filed for crypto assets unless you also held fiat currency on the exchange.
How Do I Make Amends When My Tax Returns Are Inaccurate?
There is no cause for alarm on the part of those who have already reported their crypto income and capital gains, i.e., the people that have received the 6174-A. You could have received it simply because you have a Coinbase account, not because the IRS has any real suspicions. However, those that have not accurately reported their crypto-gains must take these letters seriously, and ensure that they follow the provided instructions and amend their tax returns as fast as they possibly can.
It is worth remembering that the IRS does not usually prosecute for smaller amounts, if the taxpayer comes clean, although they are less lenient on large financial errors. Therefore, if you feel you may not have fully disclosed your crypto gains/income – due to lack of knowledge or otherwise – now is the time to act.
If you have doubts or are in need of advice, consider consulting a lawyer or CPA who has the skills to analyze the options available and show you the best way forward. However, ensure you familiarize yourself with cryptocurrency tax guidelines before you approach a CPA. Many CPAs are unfamiliar with crypto taxes and may believe crypto trading is similar to trading shares – although they are somewhat similar, cryptocurrencies are far more complex.
As Benjamin Franklin famously stated, “Two things are certain in life: death and taxes.” While the former may be scary to many of us, taxes need not be. Cryptocurrencies are gaining popularity, and investing in them has the potential to boost your wealth. However, investors should take great care not to fall prey to charges of tax evasion. This is not the time to be a tax criminal on the run, but rather a responsible citizen who abides by the rules and regulations.
Robin Singh is the co-founder and CEO of Koinly.io – a cryptocurrency tax reporting platform that automatically generates capital gains reports for exchanges like Binance, Bittrex, Coinbase etc.