This article is part of TokenTax's Cryptocurrency Tax Guide.
What Letters 6173, 6174, and 6174-A from the IRS mean
Now that the IRS has begun sending taxpayers letters about their crypto activities, you could argue that crypto has gone mainstream. The purpose of these letters to inform taxpayers that the IRS has information on their cryptocurrency holdings and trades. They advise recipients to file amended returns and pay back taxes where necessary.
These letters first started being sent in the summer of 2019, initially being sent to over 10,000 crypto holders. IRS Commissioner Chuck Rettig has stated:
Taxpayers should take these letters very seriously. The IRS is expanding efforts involving virtual currency, including increased use of data analytics. This letter is part of a wider campaign to address crypto tax, ranging from taxpayer education to audits and criminal investigations.
You can view examples of the letters on the IRS's press release.
IRS letter 6173 is the most serious letter. It requires a response by the date on the letter, whether it’s an amended return to properly include crypto or documentation supporting the fact that the crypto tax has been properly filed.
Letter 6174 and 6174-A
Letters 6174 and 6174-A do not require a specific response, but request action to be taken if cryptocurrency wasn’t properly reported. Letter 6174 states, “We have information that you have or had one or more accounts containing virtual currency but may not know the requirements for reporting transactions involving virtual currency."
Similarly, letter 6174-A states, “We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency.”
The letters also contain instructions on how to properly file crypto taxes, whether as income (Schedule C), capital gains (Schedule D), or supplemental income, like rental income or royalties (Schedule E).
The IRS has also begun to send out crypto CP2000 letters / notices to taxpayers who they believe owe taxes on crypto. The IRS sends a CP2000 when the information they have on file doesn’t match what was reported on your tax return.
The CP2000 requires a response; you can decide whether you agree with the proposed change in tax amount owed, or you can disagree per the instructions on the notice, which involves including supporting documentation.
Because the IRS’s information your crypto likely includes information they’ve received from exchanges, they may have an incomplete picture of what your crypto transaction history is. For example, they may know that you have a large trading volume on Coinbase via the 1099-K, but without your whole capital gains/losses history via the 8949, they may not know the full story.
You can respond to the CP2000 with documentation like your complete crypto tax history, calculated via a crypto tax calculator.
What does the IRS know about my crypto trading history?
Sure, in the early days of Bitcoin, people weren’t thinking about taxation. However, with Bitcoin’s adoption of value and the related IRS guidance, it’s clear that you must report your trades and pay tax on gains and income made with cryptocurrency.
While many believe that crypto is anonymous and cannot be tracked, this is not necessarily the case. Your crypto history can be tracked via your trades on fiat exchanges, and remember that most blockchains are public ledgers.
Crypto exchange reporting and Form 1099-Ks
American crypto exchanges including Coinbase and Gemini are known to send users Form 1099-Ks if a certain threshold is reached. If you receive a 1099-K, the IRS also receives a copy. The Form 1099-K is also known as the “Payment Card and Third Party Network Transactions form.” It’s commonly used by payment processors like Paypal and credit card companies to report payment transactions.
The 1099-K reports your total cumulative transaction value, including transfers in and out of the exchange. This means that the number reported may be much larger than you expect — don’t be alarmed! However, the IRS may believe that you have a higher tax owed than you actually do, in which case you should properly file your crypto taxes in order to properly represent your income and capital gain/loss.
Crypto wallets and IRS investigation
Keep in mind that, in addition to the IRS receiving information from crypto exchanges, transactions on the blockchain are largely part of a public ledger. This means that the IRS may have the ability to track transfers and transactions through the blockchain.
It has also been reported that the IRS has trained their staff on finding crypto wallets as well as evidence of crypto holdings by channels such as social media.
The truth is, unless you have a deduction or a tax credit, you will owe tax on most forms of income — including cryptocurrency gains.