IRS Ramps Up Crypto Tax Enforcement With 1099-DA Adoption

The Internal Revenue Service (IRS) has significantly increased the frequency of warning letters sent to cryptocurrency investors. These letters, primarily of three types—6173, 6174, and CP2000—serve different purposes and carry varying levels of urgency. The surge in these letters can be attributed to the upcoming adoption of the 1099-DA regulations, which is the first cryptocurrency-specific tax form by the IRS.

Many investors find these letters disconcerting, as they inform recipients that the IRS is aware of their cryptocurrency transactions and that these transactions must be reported correctly. The letters often contain specific details about the investor's crypto activities, such as ownership between certain years, which can make them feel intrusive. The IRS uses these letters to ensure that taxpayers are compliant with their reporting obligations, and non-compliance can lead to further scrutiny and potential audits.

Form 6174 is the least concerning of the three, as it is purely informational and does not require immediate action. It serves as a "soft notice" to inform investors that the IRS is aware of their crypto involvement. While it can be ignored, it is a signal for investors to review their past reports to ensure accuracy. This letter is often sent to those who used U.S.-based exchanges or had their transactions reported by third parties.

Letter 6173, on the other hand, is more urgent and cannot be ignored. It explicitly states that the IRS has information about the taxpayer's crypto accounts and suspects underreporting of crypto income. This letter can lead to an audit if the discrepancies are not addressed. The information used in these letters is often obtained from the exchanges the taxpayers use, and discrepancies can arise from errors in reporting, such as failing to report staking or mining rewards.

The CP2000 notice is generated by the IRS's Automated Underreporter Unit and includes specific amounts that need to be reported. These notices are computer-generated and can sometimes be incorrect, leading to disputes. If the amount is correct, the taxpayer can pay the due amount; if not, they should dispute it, possibly with the help of a tax attorney.

Given the increasing scrutiny from the IRS, it is crucial for crypto investors to be proactive in their tax reporting. This means diligently preparing tax reports and being ready to respond to IRS letters within the specified timeframe, usually 30 days. The upcoming adoption of Form 1099-DA will provide the IRS with even more information about cryptocurrency transactions, making compliance even more critical.

Despite the crypto-friendly stance of the current administration, the increased scrutiny on crypto transactions may fuel calls for the abolition of the IRS. However, it remains unclear whether such plans will materialize. For now, crypto investors must prioritize compliance to avoid potential legal issues.