IRS Notice CP2000 for Cryptocurrency
John Smith chatted into our live-chat support here at CryptoTrader.Tax on Friday night (we changed his true name to protect his identity). He was in a state of stress because he had received a CP2000 Notice from the IRS claiming he had under-reported his income in 2018 by more than $250,000 due to failing to include his cryptocurrency investing activity on his taxes. As a result of this under-reporting, the IRS claimed John owed $127,000 in taxes and penalties.
This Notice of course was completely inaccurate, and in reality, it was John who was actually owed money by the IRS as he had incurred $2,000 of cryptocurrency investment losses that year.
Unfortunately, John was not alone in receiving a CP2000 letter. In the past two days, we have been contacted by dozens of individuals who received the same Notice from the IRS as John.
These CP2000 cryptocurrency-related tax mishaps all stem from the fact that Coinbase and other exchanges use Form 1099K to report crypto proceeds to the IRS. This is a problem, and we dive further into it below.
How Crypto Taxes Work
The IRS treats cryptocurrencies as property for tax purposes. Just like other forms of property (i.e. stocks, bonds, real estate), you incur a tax reporting requirement when you sell, trade, or otherwise dispose of your cryptocurrency for more or less than you acquired it for. These taxes are commonly referred to as capital gains taxes.
In this sense, cryptocurrency trading looks similar to trading stocks for tax purposes.
For example, if you purchased 0.2 Bitcoin for $2,000 in May of 2018 and then sold it two months later for $3,000, 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 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. This applies for all cryptocurrencies.
Alternatively, if you sold your cryptocurrency for less than you acquired it for, you can write off that capital loss to save money on your crypto taxes.
We dive further into everything you need to know about how cryptocurrency is taxed in our blog post, The Ultimate Guide to Crypto and Bitcoin Taxes.
CP2000 - Why Did You Receive One?
CP2000 is a notice that automatically gets sent out when the IRS receives information about income that did not get reported on your tax return.
These notices often get triggered from the 1099 reporting system.
You’re likely generally familiar with how 1099 information works. There are exactly 20 different types of 1099’s in existence today (1099-B, 1099-K, 1099-DIV, etc.), and each of them serve the same general purpose: providing information to the Internal Revenue Service (IRS) about certain types of income from non-employment-related sources.
If you forget to file income from one of your 1099’s, you are likely to receive a CP2000 Notice from the IRS.
For example, if you drove for Uber all year but didn’t report any of your Uber earnings on your taxes, you would likely receive a CP2000.
This is because Uber is required to send both you (the Uber driver) and the IRS a copy of your 1099 which details your Uber earnings for the year. If the IRS detects that your tax return did not include the income you received from driving for Uber, it will trigger a CP2000 notice.
In our cryptocurrency case above, the reason John received a CP2000 is because Coinbase sent the IRS a 1099-K detailing his crypto activity of $292,427 (as seen in the picture below).
The Problem With 1099-K
As explained in our blog post about Form 1099-K for crypto, 1099-K is an informational form used to report credit card transactions and third party network payments received during the year.
The gross amount of the reportable payment on your 1099-K does not represent any gains or losses you need to report to the IRS. It solely reports the gross proceeds from all transactions you’ve made on the network—in this case Coinbase.
This is the problem with this form. Instead of reporting gains and losses (which are the real numbers you need for tax reporting), 1099-K sums up all of your trades and sells that happened within your Coinbase account and reports that number to the IRS. This makes it look like you had huge amounts of unreported income on your tax return.
1099-K was never meant to be a form for cryptocurrency exchanges to use to report income. It was designed to report earnings from platforms where you are being paid directly by third party merchants like Uber, Lyft, and Etsy. The form does not make sense in the context of cryptocurrency exchanges, and yet, many prominent exchanges like Coinbase have decided it is the 1099 they are going to use to report customer earnings information.
How Can You Solve the Issue?
If you received one of these notices, it’s smart to speak with your tax advisor.
The misunderstanding can likely be resolved by drafting a simple response letter to the IRS explaining the situation and proving to them what your actual gains and losses were. Here is a sample response letter you can use.
If you haven’t done so already, you should also calculate your gains and losses from all of your trading activity during the year in question so that you have proof for the IRS what your true income was.
Have Any Questions?
If you have any questions about the specific scenario you are in, our live chat customer support team would be happy to help! You can reach us from our live chat widget on our homepage.
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.