While cryptocurrencies are continuing to gain popularity, it’s high time to learn how to report your crypto gains in order to comply with IRS regulations and avoid undesirable consequences.
Cryptocurrency is becoming more popular and mainstream, and this has not gone unnoticed by the Internal Revenue Service (IRS). In a move that has caused panic among cryptocurrency investors, the IRS has been mass sending letters regarding tax compliance, even to those who claim they have reported their finances accurately.
In this article, we’ll cover how you can amend your tax returns to comply with IRS regulations, which tax forms to fill out, and the consequences of not reporting your cryptocurrency gains.
What Are These Letters the IRS Is Hounding Me with?
The IRS announced this year that it was in the process of sending out tax letters to crypto investors as a stern reminder of their tax obligations.
According to Commissioner Chuck Rettig, Head of the IRS, they are focused on enforcing the law and helping crypto taxpayers fully understand their obligations. The letters provide instructions on how to report cryptocurrency income, and if necessary, how to amend tax returns.
What Does Each Letter Mean?
There are three types of IRS tax compliance letters, let’s demystify them:
- Letter 6174 – This letter contains tax-compliance information you are urged to review. It is a “soft notice,” meaning that you’re not required to respond, and the IRS will not follow it up.
- Letter 6174-A – This letter is considered a “less soft notice” for potential future law enforcement action. You don’t have to respond to this one either.
- Letter 6173 – This letter is more severe and requires a response. The IRS knows you have had cryptocurrency accounts and they will follow up on this information. You must either update your information, amend your returns, or file a sworn compliance certificate.
What Exactly Does the IRS Want?
You might be skeptical about the intentions of the IRS after receiving any of these letters – and you are not alone.
Tyson Cross, a crypto tax attorney, outlined in his July 26 Forbes report, that the authority could be using the taxpayers’ list from Coinbase to send letters to thousands of US taxpayers all across the country. He states that many people have received these letters despite correct filing.
The primary intention of these letters is to scare you into action by threatening future civil and criminal law enforcement if you fail to accurately report your financial doings. The letter provides further instructions on how to report crypto income as well as how to amend your crypto tax returns if necessary.
However, you don’t need to panic if you have indeed reported your finances accurately. You don’t even have to respond to letter 6174, and the IRS will not follow it up.
However, the IRS does expect you to respond if you have received letter 6173 – so make sure you know what letter you have!
How Can I Make Amends with My Tax Returns?
Fortunately, IRS tax return amendments are not complicated. You can simply file an amendment for the previous year, or even up to 3 years prior.
You just need to mail the IRS the following information:
- Copy of your old return.
- Explain why you want to amend.
- Report capital gains and losses from your crypto investment, supported by relevant forms and schedules along with your submission. These forms include Form 8949 and Schedule D.
- File and submit Form 1040 to amend your tax return.
The IRS rarely prosecutes taxpayers who come clean about inaccurate reporting, especially when it only involves small amounts.
So, don’t ignore amending your tax returns for fear of getting into trouble. Either way, you won’t be able to run from them forever, so it’s better you deal with the situation as soon as possible.
What Forms Do I Need to Fill Out?
We have briefly touched on Form 8949, Schedule D, and Form 1040.
Now, let’s look at each form in more detail.
Form 8949. According to the IRS, partnerships, individuals, corporations, estates, and trusts use this form to report both short-term and long-term capital gains and losses from investments. Provide the company name associated with the crypto, buy and sell dates, purchase, and sale price. The form has separate sections for short and long-term trades. Ensure you put all your trades in the correct area. Spouses can combine or fill Form 8949 separately; however, they must transfer the totals from each completed form to Schedule D.
Schedule D. Schedule D is a summary of all the totals from Form 8949 separating short-term trades from long-term trades. Ensure your figures match!
Form 1040. This is a standard IRS form that taxpayers use to file their annual income tax returns. To fill it out, put your Schedule D totals on line 13 of Form 1040. Attach Schedule D and Form 8949 to your Form 1040 for the IRS to be able to verify your figures. The form is divided into sections in which you can report your income and deductions to determine the amount of tax you owe or the refund you expect to receive.
Your long-term gains qualify you for a 15% tax rate and a claim of up to $3000 in long-term losses. You can carry the claim balance forward to the following year to write off against long-term gains. In the case of short-term losses, you can write it off against your regular income.
If you are not sure how transactions like airdrops, trades, forks etc are taxed you might want to familiarize yourself with the rules by reading up on a cryptocurrency tax guide – before you begin filling out any forms.
And… What If I Don’t Do Anything?
Cryptocurrency investors must pay crypto tax on their profits; this means their income is subject to income tax. Also, consider that crypto miners qualify as self-employed and self-employment tax is around 15.3%. However, miners can potentially deduct expenses, such as electricity.
So, what happens when you don’t pay crypto taxes? Like any other form of tax fraud, you could be slapped with a minimum 5-year jail term or a maximum fine of $250,000.
Of course, everyone takes this situation with varying levels of concern. But, if you get a letter from the IRS, don’t ignore it. Correct your filings from past years, if you need to, and always pay crypto tax without forcing the IRS to remind you. If you are in doubt consider contacting a lawyer or CPA familiar with cryptocurrencies. A list of CPA’s in the US can be found here.
The IRS is more forgiving if you make amendments before an investigation or audit of your accounts takes place.
Robin Singh is the CEO of Koinly.io – a cryptocurrency tax solution that automatically generates capital gains reports for USA, Germany & Canada.