Cryptocurrency has spiked in popularity in recent years, but the tax reporting process has struggled to keep up with the changing times. The IRS considers it property, which means that gains and losses from receiving, sending, selling, or exchanging cryptocurrency must be reported on your tax return. Currently, there is no 1099 form that functions to fully report cryptocurrency transactions. The IRS has yet to issue third-party reporting requirements to exchanges who are therefore left on their own to determine what information to report to the IRS and what forms to use.
COMMON TAX FORMS USED FOR CRYPTOCURRENCY
Some exchanges will attempt to report transactions on a traditional 1099-B, the form used by brokerages and barter exchanges to record customers’ gains and losses during a tax year. However, the easy transferability of cryptocurrency makes it nearly impossible for an exchange to correctly report tax basis information. As a result, the IRS may see inconsistencies in the amounts reported by exchanges versus cryptocurrency users. In response, the IRS may send you a CP2000 notice for underreported income which can be expensive and time-consuming to resolve.
Other exchanges will issue a 1099-MISC for certain transactions, but the same problem can come up where the amounts reported may be inaccurate.
A third option is the 1099-K, an information return that shows only the gross proceeds from crypto transactions. Again, this form may be missing key details to paint a full financial picture, resulting in you receiving a CP2000.
WHAT IS A 1099-K?
The 1099-K is generally only used by businesses accepting credit card payments or payments from a money transmitting service such as PayPal. The form will show the gross proceeds from that tax year and that amount broken down by month. In the tax document matching process, the IRS computer will scan for that first total—the gross proceeds for the year.
Since the 1099-K is typically used for credit card payments, the IRS will look for the gross payment amount on Schedule C (Profit or Loss from Business), while you most likely listed the amount on Schedule D (Capital Gains and Losses). This could result in a mismatch, which the IRS could read as underreported income. The IRS has recently begun to address this mismatching error, but for the time being, taxpayers still need to be aware that this could trigger a CP2000.
One potential problem is that the 1099-K was historically not issued unless gross payments exceeded $20,000, and there were more than 200 distinct transactions. However, the American Rescue Plan Act of 2021 significantly changed this threshold: a 1099-K will now be issued for gross payments over $600, and there is now no transaction minimum. If the IRS does not provide additional guidance on cryptocurrency reporting by the end of 2021, these changes to the threshold may substantially increase the number of 1099-K forms issued by exchanges.
Another potential problem is that the 1099-K does not communicate tax basis information to the IRS. Unlike with other forms, the IRS may not be able to verify if the amount on that 1099-K is accurate without requesting additional information from you. On the flip side, many cryptocurrency users may not realize they are required to report their transactions to the IRS. If the IRS received a 1099-K and you did not report anything, a CP2000 will almost certainly be sent.
WHAT IS A CP2000 Anyway?
Even though the CP2000 is automatically generated, the notice can be intimidating for taxpayers. Some people may simply assume the IRS’ calculations are correct and pay the amount listed as owed. DO NOT DO THIS. In the case of cryptocurrency, the possibilities for errors abound, so taxpayers should always investigate their own records to see if they can account for the discrepancy and demonstrate to the IRS that no additional tax is owed.
A CP2000 should be viewed as a PROPOSED adjustment to tax and not a formal assessment. You have an opportunity- an obligation really – to respond to the IRS with an explanation and supporting documents if necessary. For instance, you can send in a letter explaining that the 1099-K shows gross proceeds and that Schedule D shows net proceeds. If available, they can also include a report from the cryptocurrency exchange showing the amount that went toward fees. Keep in mind that the arrival of a CP2000 does not mean that you should respond with an amended return, which will just delay processing.
Not all exchanges issue 1099s, so you should not rely on these to keep records of their crypto transactions. Taxpayers will simply want to provide thorough documentation to account for all gains, losses, and differences caused by fees in order to avoid the CP2000 notice.
Until the IRS provides a form that accurately accounts for third party reporting for cryptocurrency transactions, taxpayers must educate themselves on the challenges they could run into and be prepared to defend the amounts they are reporting. Taxpayers also should not be alarmed if they do receive a CP2000, since this is a common problem for cryptocurrency users and can sometimes be resolved without incurring any additional taxes.
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