Crypto Transactions and Tax Audits

When buying or selling crypto, keeping accurate records and self-reporting your gains and losses is important. This will help avoid raising any red flags that could trigger an audit.

Maintaining a complete audit dossier of all your crypto transactions will also make the process go more smoothly should you face an IRS examination. This includes documentation of significant rises and falls in income, expenses, and deductions. The IRS has made it clear that they are increasing crypto tax enforcement and that they’re going after anyone who is not paying their taxes. They have been working with contractors like Chainalysis to trace transactions and link’ anonymous’ wallets to known investors. They have also been petitioning for what’s known as a John Doe summons to force crypto exchanges to hand over KYC data on their customers. This is a hugely important development because the IRS is using this information to identify and audit taxpayers who are not filing their taxes correctly.

How Does the IRS Monitor Crypto?

The IRS has a variety of methods at its disposal to track cryptocurrency transactions. It requires people who trade in virtual currency to report their gains on tax returns, which gives it access to a wealth of data about their activity. This includes information about purchases made using cryptocurrency, sales of virtual currency, and exchanges of one currency for another.

The blockchain, the technology behind crypto transactions, is public, which allows the IRS to trace wallets back to their owners despite their appearance of anonymity. In addition, many major exchanges require users to provide personal information and follow Know Your Customer (KYC) rules, tying their identities to specific wallets. The IRS has also won John Doe summons against Coinbase and Kraken, forcing them to share user data.

Additionally, the IRS is partnering with blockchain companies to use data analytics tools like pattern recognition and machine learning to identify suspicious transaction patterns and go after U.S. taxpayers who under report their cryptocurrency gains. The agency is also ramping up enforcement of its requirement that people who trade in virtual currencies, including non-fungible tokens, answer a question about them on their Form 1040. In some cases, this can lead to a penalty for failing to report virtual currency gains.

What Triggers a Crypto Tax Audit
Crypto Transactions and Tax Audits 1

What Triggers a Crypto Tax Audit?

As with other business transactions, reporting all your crypto activity and related earnings is important. Unreported income is one of the main triggers that could lead to a crypto tax audit. Crypto investors should also ensure they file their 1099s correctly and fully comply with all reporting requirements (including the new virtual currency question on the Form 1040).

Since cryptocurrency transactions take place on blockchains that can be publicly viewed, it’s possible that any unreported crypto activity could be traced back to an individual. Additionally, major exchanges supply user records to the IRS and can cross-check the information reported by users. This means that if your cryptocurrency trading reports do not match the information provided to the IRS by the exchanges, you will likely get audited.

Other potential triggers for a crypto tax audit include unusually steep rises or falls in income, suspicious deductions, and the use of foreign assets. Additionally, if you claim too many home office or transportation expenses as business-related, the IRS may flag your return for review. Lastly, it’s important to always file the mandatory anti-money laundering forms, FBAR and 8938. Failing to do so could result in huge fines. If you suspect you are being targeted for a crypto tax audit, the best thing to do is consult with a qualified professional.

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