Are you undergoing a cryptocurrency audit? Worried you could get in trouble because you haven’t fully reported your crypto in past years? We’re here to help.
A crypto tax audit is similar to any other type of IRS audit—except your local IRS examiner may not know the first thing about cryptocurrency.
Virtual currency is taxed differently than fiat and requires painstaking calculations to report correctly. The IRS views crypto as property, not currency, which means that mining, selling, exchanging, or spending your coins are all taxable events that you need to report. Read up on how cryptocurrency and Bitcoin taxes work if you need a refresher.
Below, we’ll cover the most important things to know if you’re undergoing a cryptocurrency audit.
Crypto tax audit: The basics
Like many audits, crypto audits typically occur because the IRS has reason to believe you didn’t report all your taxable income, and therefore didn’t pay enough taxes. Some audits are also conducted randomly.
In any case, you’ll have to either prove that the tax returns in question were correct, or you’ll have to correct them and pay the IRS the taxes due. The burden is on you, as the taxpayer, to prove your tax return is correct.
The IRS has crypto records from US exchanges
Nearly all cryptocurrency exchanges based in the US now send the IRS a 1099-K each year reporting your sales data. And in 2017, Coinbase was forced to send the IRS historical data (covering 2013 to 2015) on over 14,000 users. Some foreign exchanges now send information to the IRS, as well.
If the IRS has your records from an exchange and you haven’t reported any crypto on your tax returns—or if what you reported doesn’t match the IRS’s records—this could trigger a cryptocurrency audit or worse.
On the other hand, the IRS may audit you for an unrelated reason, such as unreported wages, but your cryptocurrency trades can throw a wrench in the process.
How far back will my audit go?
A standard audit covers your last 3 years of tax returns. However, during the audit process, if the IRS finds reason to believe you’ve underreported by at least 25%, they can go back 6 years.
If you’ve had crypto for several years and haven’t always reported it properly, there’s a good chance of this happening to you.
For example, let’s say you’re going through a crypto audit covering the years of 2017, 2018, and 2019. When the IRS examiner looks at your records for 2017, they notice that some coins were sold. They ask when you first acquired those coins, and you tell them you bought the coins in 2014.
If you didn’t report any cryptocurrency before 2017, the IRS examiner may now have reason to believe that you’ve significantly underreported your taxable income. The years of 2014, 2015, and 2016 may then be opened up to an audit, as well.
If the IRS believes you’ve committed fraud, there is no statute of limitations for an audit. They can go back as far as they want in that case.
We can rebuild your crypto history (correctly)
Even if you did report cryptocurrency on your tax returns, odds are that if you’re undergoing a crypto audit, it wasn’t done correctly. And if you didn’t report at all, you’ll need a clear picture of your trading history going back for at least 3 years.
When it comes to crypto, your tax liability is based on your capital gains. The IRS can access your records from any US exchange, such as Coinbase, so they can see your crypto sales and the USD value of each transaction.
But these records do not include your cost basis (how much you initially spent on the coin that was sold), which means they paint a very inaccurate picture of your capital gains.
For example, say your crypto trades in 2018 amounted to $50,000 in sales. Without factoring in the cost basis, the IRS will treat this as a capital gain of $50,000 and slap you with a huge tax bill. But if you can show that you initially spent $40,000 on those coins, then your capital gains shoot down to just $10,000, and that’s the amount on which you’ll owe tax.
That’s a simplified example; in reality, you need to show the cost basis for every single taxable transaction.
Reconciling this data can be a painstaking, time consuming process. And, as we mentioned earlier in this article, most IRS examiners know very little about how cryptocurrency works. Do not assume the IRS will put in the work to calculate the correct capital gains for you!
We’ve helped hundreds of clients create crypto tax reports for past years, even if they don’t have complete records or have lost access to old wallets. We know the tax law and we can create crypto tax reports that hold up to the most stringent IRS examination.
After the audit: Paying your crypto tax bill
Many of our crypto clients haven’t reported because they’re afraid they won’t be able to pay the taxes they owe on crypto gains.
What most people don’t realize is that the audit process is only concerned with calculating the amount you owe. You do not have to pay your full tax bill immediately after the audit is complete.
The collections process is completely separate and usually begins months after an audit. You can create a payment plan with the IRS. And if you truly can’t pay your bill, you may want to consider an Offer in Compromise. There’s virtually always a payment plan or resolution option that works for our clients and satisfies the IRS.
Need help with an IRS cryptocurrency audit? Call our office at 847-281-3436 to schedule your confidential consultation with our experienced crypto tax attorneys.Contact Us Today »