IRS Crypto Audit: How the IRS Tracks Your Trades and What You Don’t Report

IRS Crypto Audit: How the IRS Tracks Your Trades and What You Don’t Report

Do You Have to Pay Crypto Tax to the IRS?

Yes, the IRS considers crypto transactions taxable when you buy, sell, or trade. You can also be taxed for earning cryptocurrency. Cryptocurrencies such as Bitcoin and Ethereum as well as stablecoins and NFTs are all considered to be digital assets for tax purposes. You must report income earned from cryptocurrency transactions on your IRS tax return.

When you sell crypto, trade crypto for crypto, or use it to buy something, you will pay capital gains tax. However, when you earn crypto from airdrops, mining, or staking, you will pay ordinary income tax.

How Does the IRS Know When You Buy and Sell Cryptocurrency?

Information about cryptocurrency transactions is obtained by:

Exchange and Third-Party Reports

Most cryptocurrency exchanges must issue statements for specific transactions to the IRS. Additionally, individuals receiving a 1099-B or 1099-K from one or more crypto exchanges or payment platforms should know that the IRS has a record of cryptocurrency transactions from the Information Reporting Program (IRP).

1099-Bs will be sent when you buy, sell, or exchange crypto on a platform to report capital gains and losses. 1099-Ks will be sent when you have more than $20,000 in crypto payments from a minimum of 200 transactions.

Both you and the IRS receive these forms. Failing to report 1099-B and/or 1099-K income may trigger a CP2000 notice or even an audit.

Blockchain Analysis

Although blockchain network transactions do not directly identify an individual, the IRS uses state-of-the-art software that traces crypto transactions back to users. This specific software is primarily used for requests from regulatory and enforcement agencies, including the IRS.

The IRS can also issue subpoenas and formal data requests to cryptocurrency exchanges to obtain information about users transactions and transaction history.

What Cryptocurrency Records Do You Need to Keep for the IRS?

Taxpayers with crypto transactions can avoid discrepancies between them and the IRS by keeping the following records:

  • List of wallet addresses associated with individual transactions
  • Purchase and sales dates, amounts, and transaction costs
  • Cryptocurrency transaction statements with account balances and fees
  • Mining or staking records showing rewards received, dates, and values
  • Crypto received from airdrops or forks with dates and values
  • Costs for each cryptocurrency transaction, including acquisitions and adjustments
  • Crypto market values during transactions

Are You More Likely to be Audited by the IRS for Crypto Trades?

Although the IRS does not have specific numbers for crypto audits, they pay more attention to cryptocurrency transactions due to an increase in tax evasion cases involving high-income crypto investors.

Experienced traders with significant gains or a history of complex transactions may be more likely to have an IRS crypto audit.

Failure to report amounts from tax forms issued by crypto exchanges, including forms 1099-B and 1099-K, on your tax return may result in the IRS mailing a CP2000 letter informing you that you did not report crypto income as reported by an exchange or discovered during blockchain analysis.

If you do not address the cryptocurrency discrepancy ASAP, the IRS can start an audit of your crypto transactions and taxes.

In general, all U.S. taxpayers are subject to being selected for a random audit based on various statistical factors. For example, if taxpayers report $60,000 of annual income for the past five years and then report $500,000 in crypto gains on their latest return, they have a higher risk of being audited.

Does the IRS Identify What Cryptocurrency Transactions You Didn’t Report When They Send a Crypto Audit Letter?

Yes, the IRS identifies unreported crypto in audit letters by cross-referencing tax returns with exchange reports, 1099 forms, and blockchain analysis tools.

As we have discussed, IRS systems generate CP2000 letters when they detect a difference in crypto income you report on your 1040 compared to reports received by the IRS. Although a CP2000 letter itself does not formally mean an individual is being audited, the recipient is liable for the proposed tax amount indicated in the IRS notice.

Can You Stop an IRS Crypto Audit by Submitting an Amended Return to Report Missing Cryptocurrency?

Submitting an amended return to report missing cryptocurrency transactions helps explain discrepancies to the IRS. However, it may not stop the IRS from auditing your original return, especially if the IRS suspects crypto fraud.

Whether you are okay with the IRS findings or disagree, respond to a crypto audit notice promptly and provide copies of your cryptocurrency records. If you owe crypto taxes from unreported transactions, pay the amount to avoid penalties and interest being added.

Will the IRS Help You Pay Off Crypto Taxes You Can’t Afford?

Yes, the IRS offers payment plans for taxpayers who are unable to pay total taxes, including taxable crypto income. Monthly installment agreements, an Offer in Compromise (OIC), or temporary hardship status are all tax relief options to help with IRS tax debt.

Keep in mind that even when you are on an IRS payment plan, interest will be added to your tax balance until it is paid in full.

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