Responding to an IRS Letter of Audit or Examination – What’s Involved

Even the possibility of getting an IRS letter can cause alarm, especially for crypto traders. But rather than worry, learn what’s involved and be prepared.

You open your mailbox and there’s an IRS letter asking about your crypto tax return. To respond to the audit, what work needs to be done and by who? It can be easy to panic and feel alarmed, but the best thing you can do first is to understand the process and your options.

What To Know If You Get an IRS Letter

IRS letter

To understand what’s involved, and how best you can respond, I’m going to tell you about the five main activities during an examination of crypto transactions and records.

  • Substantiation is the producing of receipts, records, and evidence of any income or expenses under question. It includes gathering all exchange transaction records and off-exchange transactions related to cryptos. Only the taxpayer knows where these records are, so collecting them is their responsibility.
  • Accounting involves summarizing taxpayer records into tax reporting categories or forms. It is a taxpayer’s responsibility, but this work can be hired out. An example of this is using a crypto-capital gains calculation service to analyze transaction records to generate a list of gains. It is a complicated activity and critical to documenting the gains for the IRS.
  • Reporting involves preparing or amending tax returns to report income and expenses or anti-money laundering forms. During an IRS examination or audit of crypto reporting, this work is done by Crypto Tax Audit at no charge for its subscribers; otherwise, Crypto Tax Audit will provide this at a reasonable fee.
  • Representation is the strategizing and responding to tax authorities. It involves communicating with the IRS or tax authorities on the taxpayer’s behalf whether in writing or verbally, on all matters. This includes responding to letters, negotiating fast track mediation or settlement, negotiating with IRS Appeals office, requesting abatement, preparing taxpayer financial statements, applying for Currently Non-Collectable status or preparing Offers-In-Compromise petitions, keeping the taxpayer updated, and performing all other taxpayer dispute and collection options available in the tax code or Internal Revenue Manual.

For crypto-related examinations and audits, Crypto Tax Audit performs these services at no charge for its subscribers; otherwise, Crypto Tax Audit performs these services for a reasonable fee.

  • Controversy is the term used to describe when a taxpayer and the IRS disagree on how a matter should be treated under the tax laws and regulations. It is a significant activity because all crypto-related transactions are new and stretch how laws and regulations are interpreted. Controversy work requires legal training because it involves statutory interpretation and analysis of prior court cases, IRS rulings, and commentary from the congressional Joint Committee on Taxation. For crypto-related examinations and audits, Crypto Tax Audit does this work at no charge to its subscribers. This is an area of significant interest and investigation by Crypto Tax Audit to prevent the most persuasive arguments during IRS representation.
  • Litigation is needed when all efforts at escalation, appeals, and use of the tax advocate service do not provide a satisfactory result. A case can be taken to US Tax Court or Federal District Courts. A fresh legal case is prepared for arguing the tax controversy before a judge. Less than 4,000 cases per year are heard because the IRS uses its Appeals group to settle cases out of court if possible. While taxpayers can represent themselves at tax court, hiring an experienced tax litigation lawyer will increase the chances of winning. Paying for a lawyer is the taxpayer’s responsibility. Crypto Tax Audit will assist subscribers at no charge on crypto-related litigation efforts.

Read More: Latest Release of IRS Crypto Tax Information – Interview with Brad Kimes on XRP

What Can an IRS Letter Entail?

IRS letter

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Not all matters require all these skill areas. Often the cost is the driving consideration.

If your IRS letter is about collecting on a debt that is not disputed, then representation service is all that a taxpayer needs.

If your IRS letter is questioning the math on a return or the omission of reporting, then usually representation and sometimes reporting services are needed.

If your IRS letter is about a formal examination or audit, then more work may be needed. Substantiation, possibly bookkeeping, reporting, representation, and controversy work are needed.

Learn More: Our Services

Protect Yourself in the Case of an IRS Letter

As a service of Donnelly Tax Law, a Crypto Tax Audit annual subscription can ensure the best protection against crypto tax risks.

It’s the proactive way to have peace of mind and know you’re protected regarding your crypto taxes.

To learn more, visit CryptoTaxAudit.com

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IRS Bluff About Crypto Like-Kind Exchange Backfired

A recent IRS bluff about like-kind exchange for crypto not only backfired, but also showed their true stance on the treatment. And it could benefit you.

This month, an IRS faux pax caused them to reveal their true position on like-kind exchange treatment for cryptocurrencies. Like-kind exchange treatment, Section 1031, eliminated tax on crypto-to-crypto trades prior to 2018. This was a treatment most taxpayers assumed.

Recent Statements About Like-Kind Exchange

At a November 2019 annual national convention of CPAs (AICPA), two guest speakers were associate lawyers at the IRS Office of Chief Counsel. This is the office responsible for all IRS court cases and formulating formal legal opinions by the IRS. One of the lawyers was the author of a recent IRS Revenue Ruling on the treatment of cryptocurrency hard forks and airdrops.

In a Q&A session at the conference, she stated that the Chief Counsel’s office didn’t believe that crypto-to-crypto trades were eligible for like-kind exchange treatment. Never before had the IRS stated any official position on this topic. Immediately, crypto news services broadcasted her comments as the official position of the IRS causing many taxpayers to become alarmed.

like-kind exchange

The Official Stance On Like-Kind Exchange

Within a week, an official spokesperson from the IRS Office of Chief Counsel announced that her comments were not the official position of the IRS. He further explained that the IRS would consider the use of like-kind exchange on a case-by-case basis. All audit cases are handled on a case-by-case basis, therefore, like-kind exchange for cryptos is not a position the IRS is automatically going to attack unless it is reported incorrectly on a case.

She was one of the key lawyers formulating the IRS’s crypto position. She was in a position to clearly know the management position on how to treat like-kind exchange. Her bluff backfired when management had to deny her statement.

This poor bluff forced IRS management to show their hand. It exposed the real IRS position on like-kind exchange for cryptocurrencies. They are not willing to prosecute a case where like-kind exchange is properly reported.

Read More: Biggest IRS Crypto Tax Guidance and What it Means for Crypto Traders

like-kind-exchange

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The Bad News and Good News About Like-Kind Exchange

This is good and bad news. This was good news for crypto traders who assumed like-kind exchange treatment was valid. This is bad news because most of these traders assumed they didn’t have to report the trades on their return. This was a mistake. If they didn’t report these trades on Form 8824, they can’t claim like-kind exchange treatment. The IRS would be correct to deny those traders like-kind exchange treatment and subject them large penalties for failing to report income.

From the legal research we have done at Donnelly Tax Law and CryptoTaxAudit, we believe the case for like-kind exchange is quite strong. I believe the case is so strong that the IRS Chief Counsel’s office persuaded the Congress’ Joint Committee on Taxation to change the law to limit like-kind exchange to real estate. Had they not done this, crypto traders would have kept their investments always in crypto and never in fiat, so that they would never have to pay taxes on that money again.

So, this bungled bluff should be an encouragement to traders to amend their 2017 returns to claim like-kind exchange treatment if it would save them significant taxes owed. Those traders who are on the fence as to whether the IRS would contest or not should also be encouraged to claim this option.

©2019

Featured image by André François McKenzie on Unsplash

Want to amend a return?

Here at Donnelly Tax Law we specialize in amending returns specifically dealing with cryptocurrencies and applying the like-kind exchange treatment if it’s beneficial for you (applicable for 2017 and prior years). Schedule a consultation with us to learn more. 

Would you rather do it yourself? Consider our Crypto Tax Fixer Package >> 

Benefit from our other resourceful ebooks:

Basics of Crypto Taxes

Free Download: Crypto Tax Health Check

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Biggest IRS Crypto Tax Guidance and What it Means for Crypto Traders

The IRS’s recent release of crypto tax guidance heralds major changes for all US taxpayers. Make sure to learn what it means for you as a crypto trader.

In early October, the IRS made its biggest release of crypto tax guidance in the past five years. And it heralds a massive change in how crypto traders report their cryptocurrency income.

The New Crypto Tax Guidance

The IRS has published an early release of the 2019 version of Schedule 1 of Form 1040. The schedule now starts with the following new question,

"At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?"

A yes or no answer is required. (The IRS defines cryptocurrencies as virtual currencies.)

This question requires all taxpayers to admit if they dabbled with cryptos during 2019.

Once a taxpayer checks this box, they are added to the list of known crypto traders for whom the IRS intends extra scrutiny.

Checking Yes to Crypto Tax

crypto tax

Photo by Julian Lozano on Unsplash.

So let’s say you check yes in 2019. What are the implications?

First, if you sold or exchanged cryptos in 2019, you must list your capital gains from those transactions. When listing a coin sold, you have to state the purchase date. If that date happens to be in a prior year, it begs the question, “did you accurately report your cryptos in that year?”.

Smart traders would go back and amend those prior year returns before the IRS finds out.

Checking No to Crypto Tax

crypto tax

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What are the implications of a crypto trader checking no?

When you sign a tax return, you are signing a statement that says under penalty of perjury, this return is true, correct and complete. Wrongly checking no would be a felony subject to fines or imprisonment.

This new Schedule 1 will cause all U.S. crypto traders to come out of the closet or permanently hide.

Need Crypto Tax Guidance?

To best learn how we can help you, let’s find out where your crypto taxes are at. Take our free Crypto Tax Health Check (download below) and visit our store to benefit from my other ebooks. 

Do you already know that you need our crypto tax services? Check out our Full-Service Crypto Tax Package or our do-it-yourself Crypto Tax Fixer Package.

Featured image by André François McKenzie on Unsplash.

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Latest Release of IRS Crypto Tax Information – Interview with Brad Kimes on XRP

We’ve just had the biggest release of IRS crypto tax information in the past five years. Here’s what to know and how to be prepared as a crypto trader.

This week has been the biggest release of IRS crypto tax information in the past five years. What is going on and what does this mean for you as a crypto trader?

I discuss this big news, and answer important questions it brings up, in my latest interview with Brad Kimes of XRP. If you haven’t already, watch the interview now. 

What Comes Next?

Over the next month, I’ll be writing more in-depth about this latest IRS crypto tax information and what you can do to be prepared as a crypto trader. 

In the meantime, subscribe to my newsletter to be notified of that and other important information regarding US crypto taxes. 

And get a 50% discount code for signing up. 

Beyond IRS Crypto Tax Information

Dealing with crypto taxes requires more than a regular tax accountant. It requires legal expertise about the US tax regulations. That’s why I have a law degree specializing in the international laws of financial regulation including taxation. I’m also an Enrolled Agent

With this background, I’ve written several books that can help you with your crypto taxes.

Do I Need My Crypto Taxes Fixed?

Wondering if you need your crypto taxes fixed? Take our free, downloadable crypto tax health check so you know if your crypto taxes need surgery or not.

Do I need my crypto taxes fixed? Should I fix my tax return to report my cryptos better? Those are the questions that many traders are asking now that the IRS compliance campaign has begun sending letters to traders. For many traders, it was the first time they ever did any investing. Reporting these investments on their taxes was a new awakening for them.

So it is time to do a health check. It makes sense. Every year you go to a doctor to have your body signs checked for hidden problems. We can do the same thing with your tax return.

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3 Proven Ways Crypto Traders can Avoid IRS Problems and Slash Their Taxes

Despite what you may have been hearing, or experiencing, crypto traders can avoid IRS problems. Ideally, you also want to slash your taxes. And you want to achieve both for good reasons. The good news is, it’s possible with these three proven ways.

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