You are not alone if you have received a letter from the IRS informing you that you need to report and pay your crypto taxes. The IRS has sent out hundreds of thousands of these letters in an attempt to remind crypto investors of their tax obligations. You’re not alone if that’s the case. The notice you received may actually be beneficial to you as it provides time to prepare for a possible cryptocurrency tax audit.
The IRS is becoming stricter with cryptocurrency, and there have been more audits concerning cryptocurrency. If you have received a notice or an audit request, don’t worry. This article provides tips on how to prepare for an IRS crypto tax audit.
What does an IRS crypto audit look like?
IRS requests for crypto audits can differ in terms of the specific questions asked. Despite their differences, there are some similarities between all of them. You will be asked to disclose:
- All wallet IDs and blockchain addresses
- All digital currency exchange accounts and P2P facilitator accounts.
As well as this, for each individual transaction, you’ll need the following:
- The date and time each crypto asset was acquired.
- Each crypto asset’s cost basis and FMV at the point of acquisition.
- The date and time each crypto asset was sold or otherwise disposed of.
- Each crypto asset’s sale price or FMV at the point of sale or disposal.
- An explanation of the cost basis accounting method used for each crypto transaction.
The IRS may also request additional information, such as records of all correspondence with counterparties related to crypto transactions, for example, emails confirming transactions.
How long does a tax audit take?
This depends on the depth of the audit. If your crypto transactions are fairly simple – for example, if you only use a few exchanges for basic trades – your crypto tax audit will not take long.
Crypto tax audits will take longer if you have a lot of different types of transactions throughout the year. This is because it is more difficult to track these types of transactions.
The audit examiner will review all the documents they initially requested and go through these documents with more experienced cryptocurrency experts. The auditor may have more questions if the audit reveals discrepancies in your tax reports.
After the audit is complete, you will receive a letter explaining the results of the audit as well as any taxes that you may owe. You’ll have 30 days to appeal this decision. However, if the IRS believes you have committed tax evasion or fraud, you may be referred to the Department of Justice for criminal proceedings.
How far back can tax audits go?
The IRS says that a standard tax audit may include checking the last three years of your finances. They can extend it to six years if they believe there are substantial errors. However, there is no limit on how far back the IRS can audit if it believes a fraudulent tax return has been filed or no tax return has been filed.
It is recommended that crypto investors keep records of their transactions if the IRS requests any information.
One way to make paying your cryptocurrency taxes easier is to use a crypto tax app like Koinly.
How to prepare for an IRS crypto audit
There are two ways you can prepare for a crypto tax audit, and one is much easier than the other, but we’ll cover both.
- Manually create crypto tax records: You’ll need to create a spreadsheet detailing all of your crypto transactions for at least the past three financial years. For each individual transaction, you’ll need the date, time, FMV, cost basis, and more. It’s a lot of work, so we recommend option two.
- Use a crypto tax app: If you use a crypto tax app, the app does all of the above for you. You need to sync all the wallets, exchanges, or blockchains you use with your chosen crypto tax app using API or import your transaction history using a CSV file. If you’re using API – in most instances – this will include your complete transaction history with a given wallet or exchange. For CSV file import, you can simply download these from your chosen wallet or exchange them and upload the file to your crypto tax app. The app then calculates your cost basis, gains, losses, income, and expenses and generates a Complete Tax Report, including each individual transaction with all the information the IRS may wish to see. You can download multiple reports to cover every financial year the IRS is interested in auditing.
How do I avoid a crypto tax audit?
There is no guaranteed way to prevent a crypto tax audit, but there are many ways to make it less likely.
Input: Make sure to accurately report your crypto capital gains, losses, and income. The IRS is very clear about what needs to be reported when it comes to cryptocurrency. In order to correctly file your taxes, you must include any crypto capital gains or losses in Form 8949 and Schedule D, in addition to your regular Form 1040 Tax Return. You must include any income you have earned through cryptocurrency in Schedule 1 of your Form 1040 Tax Return.
A lot of paperwork and math is involved if you’re an active crypto investor, but using a crypto tax app like Koinly makes this process much simpler. Koinly does all the work of calculating your crypto taxes and fills out Form 8949 and Schedule D for you – so you don’t have to spend hours on spreadsheets and calculations.
Make sure to include documentation of any large changes in income when you file your taxes. The IRS wants to know about any changes in your income – the more information you provide, the less likely they are to ask additional questions.
Be sure to carefully check your tax return for any mistakes before you file it. Making sure you don’t over- or underpay your taxes on cryptocurrency is important whether you’re using a crypto tax app or calculating them yourself.
When you are a mining registered business, you may be inclined to take advantage of as many business-related deductions as possible. You should utilize tax deductions, but don’t overdo it. Large tax deductions are a way to interest the IRS.
Should I speak to an accountant?
You should speak to an accountant if you are being audited for your taxes involving cryptocurrencies.
Crypto tax in the US is complicated, and it’s unclear how many transactions are taxable – particularly newer concepts like DeFi transactions. While a crypto tax app can calculate your capital gains, losses, and income based on current guidance from the IRS – it is not recommending or advising you on any tax-related matters. If you believe you may be subject to an IRS audit regarding your cryptocurrency holdings, it is advisable to seek professional tax advice to ensure that you are in compliance with all relevant regulations.
If you want to find an accountant in the USA who is experienced with cryptocurrency, you can use our accountant directory.
Crypto Tax Guide
Cryptocurrency’s rise and appeal as an alternative payment method
A growing number of people are interested in cryptocurrency. It is important to understand the tax implications of cryptocurrency whether you accept or pay with cryptocurrency, invest in it, or are an experienced currency trader.
Cryptocurrency is a type of digital asset that can be used to buy goods and services. Many people invest in cryptocurrency similarly to investing in shares of stock. The appeal of cryptocurrency is that it can be used as a decentralized medium of exchange without the involvement of banks, financial institutions, or other central authorities, such as governments.
Cryptocurrency has built-in security features. Transactions are encrypted with computer code and recorded on a digital ledger. Every new entry must be reviewed and approved by all network members.
You may have heard of Bitcoin or Ethereum as two of the more popular cryptocurrencies, but there are thousands of different forms of cryptocurrency worldwide.
Do you pay taxes on crypto?
Although it is called a virtual currency, the IRS does not see it as a true currency. The IRS stated in Notice 2014-21 that cryptocurrency is classified as property. This means that capital gains and losses from cryptocurrency transactions must be reported on Schedule D and Form 8949 as needed.
The decentralized, virtual nature of cryptocurrency does not affect your taxes because the IRS treats it like property.
How is crypto taxed?
The capital gains and losses you incur from buying, selling, or exchanging crypto in a non-retirement account are taxable. If you sell or exchange cryptocurrency within a year of acquiring it, your gain or loss will be short-term. It will be long-term if you hold it for more than a year.
- If you owned the cryptocurrency for one year or less before spending or selling it, any profits are typically short-term capital gains, which are taxed at your ordinary income rate.
- If you held the cryptocurrency for more than one year, any profits are typically long-term capital gains, subject to long-term capital gains tax rates.
The way in which cryptocurrency is reported on a tax return depends on the method used to obtain it and what it was used for.
You can also earn income related to cryptocurrency activities. This income will be taxed at your marginal tax rate, which could be between 10 to 37%.
How to calculate capital gains and losses on crypto
Gains and losses from the sale of capital assets are divided into two categories: long-term and short-term. There is a big difference in the way the IRS treats these two types in terms of the tax consequences you will face.
- Short-term capital gains and losses come from the sale of property that you held for one year or less. These gains are typically taxed as ordinary income at a rate between 10% and 37% in 2022.
- Long-term capital gains and losses come from the sale of property that you held for more than one year and are typically taxed at preferential long-term capital gains rates of 0%, 15%, or 20% for 2022.
The cost basis is the original value of the property plus any money you’ve put into improving it. Generally, you adjust the price you paid by any fees or commissions you paid to engage in the transaction. This final cost is called your adjusted cost basis.
After finding the sale amount, you then lower it by any fees or commissions you paid in order to close the transaction.
Finally, you subtract your adjusted cost basis from the adjusted sale amount to determine the difference, resulting in a capital gain if the amount exceeds your adjusted cost basis or a capital loss if the amount is less than your adjusted cost basis.
If you want to find out how much tax you could owe from any money you’ve made from cryptocurrency, you can use a Crypto Tax Calculator.
Can the IRS track crypto activity?
Despite the fact that cryptocurrencies are anonymous, the IRS may still have ways of tracking your crypto activity.
An example of this would be if you traded on a crypto exchange that gave you a Form 1099-B, which is a report of your trades to the IRS.
The IRS uses blockchain analytics tools to identify digital wallet activity associated with individuals suspected of tax evasion and/or money laundering.
This means that you should include all crypto activities on your tax return for the year.
How are crypto transactions reported?
This is considered a sale or exchange if you buy or sell cryptocurrencies through a brokerage or use them as a form of payment. This means you will have to keep track of your crypto sales information, including how much you bought the crypto for and when. The sales of securities are typically reported on Form 8949, Schedule D, and Form 1040.
In conclusion, if you have any cryptocurrency transactions that occurred during this year, you should prepare for an audit from the Internal Revenue Service (IRS). This includes both exchanges and purchases made through online platforms like Coinbase. While the IRS has been known to target individuals with large amounts of cryptocurrency holdings, the agency also audits smaller accounts. However, you still need to prepare for an audit even if you haven’t had any crypto transactions in the current year. So get your records together, just in case…
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