• The IRS is sending three types of letters reminding crypto owners about their tax obligations
  • A tax expert says people should contact a tax professional after receiving the letter
  • It is not clear if those with small holdings will also receive a letter from the IRS

The Internal Revenue Service has started sending letters reminding taxpayers of their cryptocurrency-related tax obligations.

The IRS sends three letters, says Clinton Donnelly, the founder of Donnelly Tax Law. Letters 6174 and 6174A are similar and they request the taxpayer to check whether or not they have reported their income.

In Letter 6173, the IRS asks the taxpayer to send a signed statement declaring that they have declared their tax statements as true, free from any mistakes. Donnelly told that Letter 6173 is sent by the IRS to those they suspect have engaged in criminal tax evasion and that the IRS has enough evidence of a wrong-doing.

So, what cryptocurrency owners should do when they receive an IRS tax letter?

Upon receiving a tax letter, the taxpayer has to contact a tax professional who understands the cryptocurrency auditing process. Donnelly says receiving a letter means the taxpayer is already on the IRS's audit radar and that there is a high chance they will be audited.

"It can be expensive to defend yourself against the IRS because audits often take a year and a half to resolve. This stress can take a heavy toll on letter recipients," he added.

The tax expert also said his clients who received the 2019 letters had cryptocurrency portfolios valued over $900,000 in 2017. Those who received the 2020 letters had $100,000 in the portfolio in 2017.

What if the taxpayer only has a small portfolio?

It was not clear if those with small holdings would also receive a letter from the IRS. Donnelly said the IRS might not have the resources to send to every cryptocurrency holder. There is also no evidence as to how the IRS identifies taxpayers.

What are the penalties for those who fail to report their crypto income?

If the taxpayer underpays their tax, there is a failure-to-pay penalty which is 0.5% of the understatement per month for the first 36 months from when it was due, Donnelly added. The interest rate changes quarterly. He added that there is also the "accuracy-related penalty". "This penalty is 20% of the understatement if the additional tax more than the greater of 10% of the tax required to be shown on the return for the taxable year or $5000," he said.

According to the IRS, cryptocurrency is a form of virtual currency and therefore, it is treated as property. General property tax principles apply to virtual currency transactions.

In a new memo from the IRS Tax & Accounting Division, senior technician reviewer Ronald J. Goldstein confirmed that cryptocurrency received as payment for microtasks is also taxable, even if the value of the said transaction is $1.

IRS has inked a contract with Blockchain Analytics and Tax Software, a blockchain firm, to help expand its cryptocurrency tracking and tracing tools. The deal was signed on Tuesday for a $249,900 contract. In a statement to Cointelegraph, the IRS said this new transaction is not related to an earlier report wherein the bureau put out a request for a cryptocurrency transaction tracking program.

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This picture shows a person holding a visual representation of the digital crypto-currency Bitcoin, at the 'Bitcoin Change' shop in Tel Aviv, Israel, Feb. 6, 2018. JACK GUEZ/AFP/Getty Images