The IRS is beginning to crackdown on individuals who transacted with Bitcoin and other cryptocurrencies but did not report it on their taxes.
Recently, there have been reports that some taxpayers have received warning letters from the IRS. These letters come in three variations 6173, 6174, and 6174-A, and they specifically address cryptocurrency holdings:
“We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.”
The IRS treats cryptocurrencies as property for tax purposes, not as currency. Just like with other forms of property—stocks, bonds, real estate—you incur a tax reporting liability when you sell or trade your cryptocurrency for more or less than you acquired it for.
For example, if you purchased 0.1 Bitcoin for $1000 in April of 2018 and then sold it two months later for $2,000, you have a $1,000 capital gain.
You report this gain on your tax return, and depending on what tax bracket you fall under, you will pay a certain percentage of tax on the gain. Rates fluctuate based on your tax bracket as well as depending on whether it was a short term vs. a long term gain.
In order to report these gains and losses on your taxes, you need to have records of your cost basis and fair market value for each sell or trade of your cryptocurrencies at the time of sale. Cost basis is simply the amount of money you put in to acquire the asset. Fair market value is just the dollar value that you received upon sale or disposition of the asset.
Staying with the example above, your cost basis is $1,000, and your fair market value is $2,000. You would report each of these figures along with the $1,000 gain from the transaction on your tax documents. This process should sound familiar if you invest in or trade stocks, as it is the same reporting process that stock traders go through.
You can read our 2019 Cryptocurrency Tax Guide for a more complete and thorough overview.
First of all, you're not alone if you received this letter. The IRS sent out more than 10,000 of these letters to many early Coinbase customers—not just suspected tax cheats. What you should do varies by the type of letter received. Letter 6174 & 6174-A are no action letters. This means you do not have to respond to these letters if you have met all the crypto tax filing obligations outlined in the letter. These letters recommend that you file amended or delinquent returns if you think you did not appropriately file crypto taxes in past years.
In contrast, Letter 6173 requires your action. If you do not respond to this letter on time, your tax account will be audited by the IRS. You should read through "What you need to do by the 'respond by' date above" section on the letter and provide necessary documents to the IRS. A qualified tax professional along with the help of CryptoTrader.Tax reports can help you navigate through letter 6173 requirements.
You can use IRS Form 1040X to amend previous year’s tax returns.
You can also use popular tax filing software programs like TurboTax to file an amendment.
It is important to note that these are educational letters sent by the IRS, and you may get it despite being fully compliant with all your crypto tax reporting. The intent of these types of mechanisms is to increase cryptocurrency tax reporting compliance and not necessarily to penalize the taxpayers.
You need two forms for the actual reporting process when you are filing or in this case amending your taxes: the 1040 Schedule D and the 8949. The 8949 is the important form that you will need to create to amend your previous year’s returns.
You will use the 8949 to detail each Bitcoin and cryptocurrency taxable event that occured during the year as well as the gains and losses that you realized on each trade. Total these up at the bottom of the 8949, and then transfer the total sum onto the Schedule D. Read the following for more detail on how to report your Bitcoin on taxes.
Because cryptocurrency data is often scattered across many different exchanges, wallets, and other platforms, it can be difficult for users to report all of their activity on Form 8949.
Most trades are quoted in other cryptocurrencies and not U.S. Dollar values which adds to this problem. To top it off, cryptocurrency exchanges are unable to provide their users with accurate tax reports due to the transferable nature of digital currencies.
You can read more about why exchanges can’t give users accurate tax reports in our article: The Cryptocurrency Tax Problem.
Many cryptocurrency users are turning to cryptocurrency tax calculators to help them automate the entire process of building Form 8949 and other tax reports for their cryptocurrency transactions.
You can use software like CryptoTrader.Tax to automatically generate your required forms. You can then give these forms to your accountant so that they can properly amend your previous tax returns with them, or you can use the forms to amend your tax returns yourself.
Below is a video explaining how the CryptoTrader.Tax platform works.
As always, it is smart to consult a tax professional if you received this type of letter from the IRS.
However, because bitcoin and cryptocurrency is still such a new concept, many accountants are not familiar with how the digital asset is treated from a tax perspective. It is important to speak with someone who is familiar with crypto.
Because of this, we put together a directory of crypto tax professionals who work in the space for our users
Disclaimer - This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA, or tax attorney on how you should treat taxation of digital currencies.