The IRS has already begun sending out letters targeting cryptocurrency investors and traders who they believe have failed to report or who have misreported their crypto gains.
The letters 6173 and 6174 (and 6174-A) emerged following a 2018 court order that directed cryptocurrency exchange Coinbase to turn over the account details of its U.S. customers to the IRS.
Did you get a letter?
Tax experts urge that you take steps and learn what all of this means for you as a taxpayer. Even if you haven’t received one of the dreaded letters, you should still make sure you are complying with tax regulations.
The skinny on those IRS letters
- If you have received letter 6174-A, this means that the IRS is telling you that they have reason to believe you have partaken in transactions using cryptocurrency and could have misreported or neglected to report these when filing your returns.
- The two letters are basically asking you to review all your cryptocurrency transactions to make sure you did file indeed accurately and that you fully comply with U.S. tax reporting requirements.
- If you have received this letter, then the IRS is telling you that they know you have partaken in transactions using cryptocurrency and you need to file returns (if not filed already) or amend your returns to reflect the capital gains or losses from said transactions.
- The IRS requires that you respond to this letter as per the “respond by” date, even if you believe you have properly filed your crypto tax returns.
- Your response must describe the details of the transactions, how you reported them in your returns, and why you believe you are compliant. You must then sign this response and mail it to the IRS.
I forgot to file my gains, now what?
If you simply forgot (or purposely ‘forgot’) to file your crypto trades along with the rest of your tax returns, then you should know that the IRS is strongly encouraging you to fix your mistake. And failing to do so will attract unnecessary trouble from the authorities who are already revved up for a crackdown. You absolutely don’t want to end up with an audit or massive tax bill that you won’t be able to pay.
So how do you go about becoming compliant? Take a proactive approach and follow IRS’s advice.
The good news is: the law gives you up to three years to file an amendment to earlier returns. And you really want to show the IRS you are prepared to follow the crypto tax rules.
So, how exactly can I amend my returns?
Before you look at how to amend your previously filed returns, here is a quick summary of how to file your crypto tax reports.
- Generate a record of all your crypto trades (you can pull this from your exchange accounts or use crypto tax software to easily get the data).
- Note down the cost basis and fair market value of each trade. Cost basis, by the way, is the overall cost of acquiring the cryptocurrency while the fair market value (FMV) refers to the value of the asset at the time of disposal.
- Use the cost basis and FMV data to calculate your capital gains or losses.
- Accurately fill out Form 8949 and Schedule D and submit.
Get those returns amended
Amending your returns requires you to gather all your records, as said above, and determine what you owe in taxes. Use the details to calculate what you owe in capital gains or losses. Then remember to do this for every trade.
For example, if you used $100 to purchase BTC (where the price includes transaction and exchange fee) and sold it at $300, then your cost basis is $100, and the FMV is $300. Your capital gain, thus, is $200 to which you owe tax.
Now, calculating the capital gain or loss for every trade could prove a problem even to the savviest so you might want to consider using crypto tax software to automate it for you.
Once you have done all the calculations, move to the next step by getting all the forms required for you to file capital gains.
You already know that you need Form 8949 and 1040 Schedule D to file your cryptocurrency capital gains. Specifically, all your crypto trades will go on Form 8949 and you report your capital gains and losses using Schedule D.
However, to amend the returns, you need IRS Form 1040X. This form is titled “Amended U.S. Individual Income Tax Return” and is only for adding new information.
Mail Form 1040X, after filling it out, to the IRS to amend your returns. Also, ensure you attach all documents that will support your amendments.
And what if I don’t report my crypto gains?
There has been a misconception among some traders that the anonymous nature of crypto makes it difficult for tax authorities to find out who has been trading crypto and so who owes capital gains taxes.
Well, even if some blockchain transactions on privacy-oriented coins can be a challenge to trace, the government has already proved what they can do when they subpoenaed Coinbase and got the account details of nearly 13,000 U.S. citizens. Also, all regulated exchanges have some kind of KYC mechanism.
Notably, the notices the IRS has sent out are the first stage of a potential crackdown that aims to take down those who use cryptocurrency to evade taxes. So, don’t take the risk!
If you do try to evade taxes, you could face a huge tax bill with interest and other penalties. The IRS can even start criminal charges against you, potentially leading to a five-year jail sentence and heavy fines.
The Bottom Line
You need to take the IRS seriously, whether you have received a letter or not. Cryptocurrency taxation and regulation are already here. And now, governments around the world have begun hunting for crypto tax cheats, so it is the absolute best option for you to stay on the good side of the law.