Are you facing a cryptocurrency tax audit? Audits are never easy to deal with, and crypto trading makes the process significantly more complicated. And new 1099-DA reporting requirements will lead to more crypto tax audits than ever before, so it’s important for investors to be prepared.
The experienced crypto tax attorneys at Gordon Law have been working in crypto tax law since 2014. We’ve helped countless clients through the audit process and even defended multiple crypto tax audits.
In this guide, we’ll help you understand what to expect in a crypto tax audit and how to prepare.
Undergoing a crypto tax audit? Time to call in the pros
Did you receive notice of 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.
Here are the most important things to know if you’re undergoing a cryptocurrency audit.
How a cryptocurrency audit works
Whether you’re being audited because of your crypto holdings, or your investments are simply complicating the process, the goal is to prove that you filed your tax returns correctly and paid the correct amount.
Here’s how the cryptocurrency audit process works:
- The IRS will request records to support the information on your tax returns. This can include paychecks, bank statements, and receipts for any expenses you claimed.
- In the case of an IRS cryptocurrency audit, you will also need a detailed report of your trading history for the years in question.
- The audit examiner’s primary goal is to determine whether you reported correctly and paid the right amount in taxes. Missing cost basis for crypto often causes problems with the calculations. Additionally, the IRS uses crypto tax software to determine how much tax you owe, and this software may cause errors.
- At the end of your audit, the IRS will assess the amount owed. Collections won’t begin right away, and you do have the option to appeal.
- If, during your crypto audit, the IRS finds reason to believe you intentionally tried to hide funds or otherwise committed a tax crime, they may refer the case to the Criminal Investigations Division or the Department of Justice for criminal prosecution.
See our blog post for tips on what to do if the IRS audits you.
Why was I selected for a crypto tax audit?
Like many audits, cryptocurrency 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. IRS Notice CP2000 and IRS Notice CP2501 are commonly used to initiate a crypto tax audit.
Some audits are also conducted randomly. Learn more about common reasons for a tax audit here.
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 any taxes due. The burden is on you, as the taxpayer, to prove your tax return is correct. That’s why it’s important to seek professional help to defend your rights, especially in the case of a cryptocurrency tax audit.
The IRS has crypto records from US exchanges
Nearly all cryptocurrency exchanges based in the US now send tax information to the IRS. The IRS has also used John Doe summons to collect data from exchanges in the past, including Coinbase and Kraken.
Soon, Form 1099-DA will report more information than ever before. See our blog post explaining why Form 1099-DA will lead to an unprecedented amount of crypto tax audits.
If the IRS has your records from an exchange and you haven’t reported 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 unusually high deductions, but your cryptocurrency trades can throw a wrench in the process.
How far back will my cryptocurrency tax audit go?
A standard tax 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 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 tax fraud, there is no statute of limitations for the audit. They can go back as far as they want in that case. Learn more about how far back the IRS can go during an audit here.
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 cryptocurrency audit is complete.
You can create a payment plan with the IRS. There’s virtually always a payment plan or resolution option that works for our clients and satisfies the IRS.
You can even appeal your crypto audit results! Our tax audit attorneys are licensed in US Tax Court, so we can appeal your audit decision to the highest levels.
Why you need an experienced professional for your cryptocurrency audit
As we mentioned above, most IRS examiners don’t even know what Bitcoin is—let alone how it should be reported. You need a tax lawyer on your side who:
- Knows how to navigate the audit process
- Can prepare an accurate crypto tax report
- Knows crypto tax law inside and out so they can defend your return
A crypto tax report is a detailed accounting of every single trade—including timestamps of when you bought and sold, the initial amount you spent on the coin, and how much you sold it for. This information is used to calculate your capital gain or capital loss for each transaction.
See our crypto tax guides for more information:
Building a proper crypto tax report can be a painstaking, time consuming process. Do not assume the IRS will put in the work to calculate the correct amount owed for you! Learn about common issues with missing cost basis here.
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 law inside and out, so we can create crypto tax reports that hold up to the most stringent IRS examination.
Trust Gordon Law for your crypto tax audit
Few firms have the knowledge and experience needed to successfully defend a cryptocurrency tax audit. But the crypto tax lawyers at Gordon Law have focused on crypto since 2014; prepared more than 1,500 crypto tax reports; defended multiple IRS cryptocurrency audits; and helped thousands of investors save on their taxes.
If you’re selected for an audit, don’t let the IRS push you around. Call Gordon Law now for experienced and aggressive representation.
