The Ultimate Crypto Tax Audit Guide for 2024 (2024)

The IRS conducts tax audits to ensure compliance. Audits can be random or triggered by suspicious activity, which of course taxpayers should do everything in their power to avoid. Common, general audit triggers include:

• Math errors.

• Failure to report income.

• Excessive claims of charitable donations.

• Large business expense deductions.

• Claiming a home office deduction without meeting the criteria.

• Using round numbers instead of precise amounts.

Crypto-specific activity that might trigger an audit includes:

• Failure to accurately report crypto transactions and income.

• Large transactions or significant gains.

• Inconsistencies or discrepancies.

• Use of privacy-focused coins.

• Participation in offshore exchanges.

The simplest way to ensure thorough crypto tax filings and avoid triggering an audit is to use crypto tax software and work with trained experts like our team at TokenTax.

When responding to IRS audit requests for your cryptocurrency taxes, it's important to anticipate a set of common initial inquiries. To ensure a smooth process, it's advisable to provide transparent and well-organized responses. The IRS typically requests the following information:

• Wallet IDs and blockchain addresses: All wallet IDs and blockchain addresses controlled or owned by the taxpayer.

• Digital currency exchange details: Information on all digital currency exchanges (DCE) and peer-to-peer (P2P) facilitators, both foreign and domestic, including associated user IDs, email addresses, IP addresses, and account numbers related to those platforms.

• Details about transactions: You’ll be expected to report the date and time each unit of virtual currency was acquired, the basis and fair market value of each unit at the time of acquisition, the date and time each unit was sold, exchanged, or otherwise disposed of, and the FMV of each unit of crypto at the time of disposition, exchange, or sale, and finally the amount of money (or the FMV of property received) for each unit.

• Explanation of which method was used to calculate the basis related to the sale or disposition of the cryptocurrency. (Note that this refers to the crypto accounting method).

These details are essential to satisfy IRS requirements and maintain compliance during a cryptocurrency tax audit.

If the IRS decides to audit your cryptocurrency taxes, they'll send you a letter. Audits can happen through mail or in-person interviews. By law, you must keep tax records for at least three years, but the IRS can look at the past six years. So, it's best to keep records for at least six years.

During the audit, they'll check your financial records, including your cryptocurrency trading history, bank statements, credit card payments, loans, tuition costs, and insurance payments. If your expenses are much higher than your reported income, the IRS might see it as hiding income.

Even though the auditors might not know much about cryptocurrency, the IRS has experts who help them behind the scenes. The length of a tax audit depends on how complex your financial history is and what they're checking. If they find issues, they might need to ask more questions.

Once the audit is done, you'll get a letter from the IRS explaining what they found and if you owe taxes. You have 30 days to challenge their decision. If the IRS suspects tax fraud, they might involve the Department of Justice.

What will I need for a crypto audit?

For a crypto audit, you need records of your crypto activities for at least the last three years, maybe six. You must accurately report your crypto earnings, including transaction history, how you calculate capital gains, and all crypto activity.

You should provide for each crypto transaction:

• When you received the crypto.

• The crypto's value when you received it.

• When you sold the crypto.

• The crypto's value when you sold it and what you got in return.

• The method you used to calculate capital gains.

The IRS will also ask for:

• Details of exchanges and wallets, including user IDs, email addresses, and IP addresses.

• All your blockchain addresses and wallet IDs.

The IRS might look at more than just your crypto, so keep good records of all your tax-related info, like income, expenses, deductions, and assets. During an audit, you might also have to provide documents like proof of where you live and social security numbers for you and your dependents.

You can use crypto tax software, like TokenTax, to make this process easier by automatically syncing your transactions from popular exchanges and wallets.

How far back does a crypto tax audit go?

The IRS usually audits tax returns filed in the last three years. If they find a big mistake, they might go back further, but usually not more than six years. By law, you must keep records used for tax returns for at least three years from when you filed the return.

How long does a crypto audit take?

The length of a crypto tax audit depends on your situation. It's influenced by how complex your financial history is and what they're looking at. Most audits don't go past three years, but they might ask for more time.

There's no set time for an audit. It depends on how much investigating they need to do and how long it takes to gather and review all the information. Extra questions or examinations could make it longer. After the audit, you'll get a letter from the IRS with their findings and any taxes you owe. You have 30 days to appeal if you want to.

The simplest way to ensure your crypto activity does not trigger a tax audit is to properly report your crypto activity each and every year. Our platform is built to support this, and our expert team is available to help.

Accurately report crypto activity

Accurately report your crypto earnings every tax year by including the following information:

• Your complete crypto transaction history.

• The accounting method used for calculating capital gains (FIFO, LIFO, or HIFO).

• Any relevant assumptions not represented within the data.

Use crypto tax software

Utilize cryptocurrency tax software like ours at TokenTax, which provides automatic integrations with popular exchanges and wallets. Our crypto tax calculation software will help you:

• Sync all your transactions automatically.

• Efficiently file an accurate tax return.

Double-check your tax return

Thoroughly check your tax return to avoid simple mathematical errors. Carefully review and verify your calculations, especially if you have engaged in numerous cryptocurrency transactions.

Provide additional documentation when necessary

Provide additional documentation to explain any steep rises or falls in income or expenses. This may help address any suspicions and provide clarity to the IRS regarding significant financial changes.

Be cautious about deductions

Exercise caution when reporting home deductions for a cryptocurrency-based business, such as a mining operation. Remember:

• You can deduct business-related expenses.

• Unusually large deductions relative to your income might be a red flag that attracts the attention of the IRS.

Implementing these precautions and maintaining accurate records can help reduce the chances of being audited and ensure a smooth and easy tax filing process, especially when paired with our platform and expert team at TokenTax.

Yes, it’s best to assume the IRS has full transparency into your crypto activity. The IRS has increased efforts to enforce crypto tax compliance, and tax evasion can result in penalties, fines, and even criminal charges.

While crypto transactions (particularly in DeFi, off centralized exchanges) are generally pseudonymous, the IRS can still identify your crypto transactions and other activity through a variety of methods:

• Coinbase or other exchanges: If you have conducted cryptocurrency transactions through centralized exchanges like Coinbase, the IRS can request information from the exchange about its users' transactions. Because such platforms are typically necessary for fiat on- and off-ramps, this is more or less unavoidable.

• Third-party services: The IRS can also potentially gather information from other third-party services, such as blockchain analysis companies, that specialize in tracking and analyzing cryptocurrency transactions.

• Patterns and behavior: If you engage in large or frequent transactions involving cryptocurrency, especially when converting it to traditional currency, it may raise red flags and potentially attract the attention of the IRS.

The different types of crypto tax audits

To be clear, there aren’t crypto-specific tax audits, although your crypto activity might trigger an audit and thus come under scrutiny. If the IRS audits you, your entire tax history over the previous six years could be assessed, including your crypto activity.

Crypto tax audits proceed like other audits, with additional attention given to crypto transactions for those who engage in crypto-related activity.

The three most common types of IRS audits taxpayers may have to deal with are:

• Correspondence audits are the most common type, during which the IRS sends a letter and requests more information or proposes adjustments.

• Office audits require the taxpayer to visit an IRS office for a more detailed examination of their return, typically focused on specific issues (such as cryptocurrency activity).

• Field audits are the most comprehensive and intrusive, conducted at the taxpayer's home or business by IRS agents.

By keeping comprehensive and current records of crypto activity and accurately reporting crypto every year with TokenTax, taxpayers can work to avoid, and be prepared for, any degree of IRS scrutiny.

"Remember, an IRS audit is a routine process that doesn't necessarily mean there's something wrong. We will work with you to provide the necessary information to achieve the best possible outcome."
- Ty Gaines, EA, Tax Expert

If you are audited by the IRS and need assistance with the crypto portion of your returns, our team of expert crypto accountants is available to help you get the data you need for your crypto transactions. Our software will automatically import data from various wallets and exchanges and allow you to efficiently deliver the IRS the information needed concerning your crypto activity.

With TokenTax, you can import data from every crypto exchange, blockchain, protocol, and wallet. Just upload them in a supported CSV format or sync your transactions via API.

Here are answers to frequently asked questions about cryptocurrency tax audits.

Which crypto exchanges do not report to the IRS?

Centralized exchanges operating entirely outside the United States, such as Binance, do not as a rule report to the IRS. Centralized exchanges serving users in the United States, as a rule, report to the IRS and/or require KYC, which identifies a user. For example, Coinbase reports to the IRS in a similar fashion to Binance US.

Exchanges are also required to send Forms 1099-MISC to the IRS and users who have earned more than $600 from staking, rewards, or similar programs.

What are the odds of a crypto tax audit?

In 2022, the IRS audited 3.8 out of every 1,000 returns (or 0.38%), according to a report using IRS data from Syracuse University’s Transactional Records Access Clearinghouse. That said, we strongly encourage taxpayers to do everything in their power to avoid raising red flags, which means properly filing your crypto taxes each and every year.

What triggers a crypto audit?

The risk of a cryptocurrency tax audit is heightened by factors such as non-compliance, including inaccurate reporting or tax evasion, as tax authorities actively work to ensure crypto tax compliance.

Engaging in large cryptocurrency transactions or realizing significant gains may attract attention and scrutiny from tax authorities, as might privacy-focused coins or the use of offshore exchanges.

Inconsistencies or discrepancies in tax filings, such as mismatched information between reported income and crypto transactions, can also raise red flags. Additionally, audits also occur randomly as part of routine enforcement efforts, regardless of diligent reporting.

What happens if I don’t report crypto?

Not reporting cryptocurrency on tax returns can lead to serious repercussions. Specific consequences vary depending on the jurisdiction, but in general, taxpayers must report crypto to avoid penalties, interest, and potential criminal charges.

If you have failed to report crypto on your taxes for the current or past years, it is important not to panic. There may be an opportunity to amend your returns, and it is better to file crypto taxes late than to not report them at all.

Will the IRS audit you for crypto?

The likelihood of an IRS audit for cryptocurrency depends on factors like compliance with tax rules, reporting accuracy, and financial crypto activities. While audits aren't guaranteed, proper yearly crypto tax filing reduces audit risk.

How does the IRS monitor crypto?

The IRS tracks crypto transactions through exchanges like Coinbase, which may share data for US users. Third-party blockchain analysis companies also provide information. Engaging in significant or frequent crypto transactions can draw IRS attention.

Remember, cryptocurrency activities can be traced, and non-compliance could lead to penalties, fines, and legal consequences. Consult a cryptocurrency tax specialist to stay compliant with evolving regulations and ensure a smooth tax season.