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audit defense crypto taxes May 15, 2023

If you received a CP2501 letter from the IRS, read this...

Attention: If you received a CP2501 letter from the IRS, read this…

If you ignore a CP2501 letter, it will get much worse…

Screenshot of an IRS CP2501 notice which states that a tax return does not match the information that the IRS has on file.

A CP2501 letter is a “pre-audit letter”. It means the IRS supercomputers have flagged your tax return for underreporting income. That’s not good.

Read this whole letter. It’s got lots of good info and a solution to your problem.

What did you do wrong?

Yes, you did something wrong. The IRS knows about more income than you reported on your tax return. They call this underreporting. Maybe you hid something or maybe you just didn’t properly account for all your income. Either way, what the IRS knows about you and what you disclosed just don’t match up.

How do they know?

The IRS learns how much income you received from companies filing 1099, W-2, and K-1 tax forms about payments they made to you. When your tax return doesn’t account for all this income, then the IRS decides you underreported income and underpaid your taxes. That’s why they’re coming after you.

Why is this a pre-audit letter?

In 2021, the IRS issued thousands of CP2000 notices to crypto traders proposing outrageous tax assessments because crypto exchanges like Coinbase and Uphold, had issued 1099 forms to the IRS that overstated the trader’s crypto income. The IRS handled this poorly with many cases going to Tax Court. Tax Court became angry at the IRS and forced the IRS to reconsider all these cases before Tax Court would handle them.

The IRS has changed its strategy. Now they issue a CP2501 which they call an “Initial Inquiry Letter” to get information from you. If they are not satisfied with your response, then you will be sent a CP2000 letter proposing you owe more taxes, penalties, and interest.

How much $$$ will the damage be?

You will be charged taxes on the unreported income based on your marginal tax rate. A 20% substantial tax understatement penalty is added.

Here's a story about James:

If the understatement is greater than 25% of your adjusted gross income or for other reasons, the penalty is increased to 40%. If the examiner feels your return was fraudulent, the penalty can increase to 75%. Cumulative interest is also significant.

Working with the IRS is very, very frustrating.

One client came to us, after having botched his initial response to the IRS. Since his job required a government security clearance, he was suspended from duties by his employer because he had unresolved tax assessments. When we were done, he owed nothing more and got his job back.

Another client came to us frustrated with communicating with the IRS. Because he owed the IRS about $71,000, his passport was frozen so he could no longer travel internationally. We restructured the debt and unfroze his passport, all without having to disclose his crypto holdings to the IRS.

How not to respond to the IRS.

Do not be an ostrich and ignore the letter. Many people are paralyzed by fear and uncertainty. You need to respond in the thirty days given if only to ask for an extension.

Do not call the IRS. Currently, they only answer the phone less than 10% of the time.

If you are on hold too long, they will do a “courtesy hang-up” of your phone call. (They hang-up on you before you hang-up on them.) You will never talk to the same person a second time. They record your phone call including things you say while on hold (think about that…).

Do not mail your response to them. Your response must be faxed. So archaic. You still have a fax machine, don’t you? It’s in your basement next to your VHS video tape of the movie Star Wars.

Do not answer their questions the way they ask them. They will list some differences between your return and the crypto exchange 1099 form they have. They start from a position of assuming that the form 1099 is correct and your return is incorrect. The problem is that the form is not correct. The rules crypto exchanges follow to generate a Form 1099 do not match the rules you must follow to report crypto income. Even if you failed to report your crypto income, the IRS’s form is still wrong.

Do not expect the IRS to call you on the phone to chat about your problem. They ask for your phone number, but they will never call you. They are overworked.

Do not call the Taxpayer Advocate Service. You have to work with the IRS first.

Don't forget to recalculate all your crypto capital gains nor claim all your losses, rug pulls, scams, and abandoned tokens. And do not ask someone to help you who doesn’t have significant experience fixing cryptocurrency tax problems with the IRS. You need the A-Team to defend you!

Why do you need help?

The IRS has a sophisticated procedural system of performing audits and appealing (disagreeing with) the audit results. It is mostly described in the IRS Internal Revenue Manual (IRM). Defending yourself in an audit is more than just being right. It is about knowing how to beat them at their game.

I’m very competitive. I love the game. I don’t just want to win. I want to make the IRS pay.

Here's a story about Jeff:

The description of a situation where Jeff was audited by the IRS for three tax years when they saw he had reported crypto transactions on his tax returns.
Following IRS representation provided by CryptoTaxAudit, Jeff received a $48,352.69 refund check from the IRS as a result of a successful audit defense.

The IRS thought they could shake Jeff down for more money, instead we made the IRS pay handsomely for their mistake. Almost half of our audit clients end up with refunds instead of owing. I love the game.

Who can help you?

You need an expert.

You need someone who is both a specialist in cryptocurrency reporting and the IRS audit-appeals process. This person is usually a CPA, an Enrolled Agent, or a tax lawyer. CPAs are most experienced in handling an audit but avoid handling the appeals process. Conversely, tax lawyers are experienced with the appeals process but usually delegate the audit response to a CPA. Enrolled Agents can be experienced in both audit and appeals processes.

Regardless of which specialist you choose, be certain they have significant experience with cryptocurrency cases. Let crypto novices make mistakes in someone else’s case.

Why are we the best to defend you?

CryptoTaxAudit is the largest firm specializing in cryptocurrency tax defense for U.S. crypto traders. We have several CPAs who specialize in tax returns reporting crypto income. We have Enrolled Agents with law degrees. And, we have certified tax problem resolution specialists.

We do our own crypto gain calculations in-house. We don’t subcontract to other firms. By calculating your gains ourselves, we can explore alternative ways of reporting that reduce taxes and gives us a stronger defense against the IRS.

Another client used TurboTax and never reported his crypto income in 2018. Coinbase reported a form 1099-K to the IRS showing $380,947 of gain. The IRS demanded payment of $151,112. Our team recalculated his entire crypto income to show a small loss instead of a gain. Net result: James got a $68 refund and our charge for the entire effort was under $500. With one letter to the IRS, we fixed his problem. But, they are not always that simple.

How much do crypto audits cost?

Cryptocurrency audits are always considered complex to audit, appeal, and litigate in Tax Court. The IRS brings in specially trained crypto experts. Often, they hire third-party consultants to calculate and attack your crypto reporting their way. Defending against these experts requires expensive forensic accountants to speak to the IRS Appeals officers or at Tax Court.

Most lawyers and CPAs charge by the hour which means you have no idea what your defense will ultimately cost. Audits usually take about 16 months to conclude. Many crypto audits get escalated to IRS Appeals or even to Tax Court. The Appeals process can take a year. Tax Court can take a year or more. Paying by the hour could bleed you dry.

Industry experts estimate an average audit will cost $10,000 per year for representation services, not including the cost of consultants. That numbers can grow to tens of thousands very quickly if the IRS decides to audit multiple years’ of your tax returns and you need representation for the typical 3 years required to take a tax case all the way to tax court!

To help save clients’ money, lawyers offer a variation of a do-it-yourself support service where you do all the work and pay the lawyer a fixed amount for his advice. Crypto audits are too complex for this strategy.

How much do we charge?

To defend a client in a CP2501 case, we charge nothing extra. As an Audit Defense member with representation benefits, we protect you for the length of the representation. If recalculation of your crypto income is needed, we charge for our in-house analysts to do this for you. Note that this benefit is included in the Full Protection membership plan. The price to calculate averages between $2000-$4000 depending on the complexity. That’s per tax year under audit.

Our monthly Audit Defense membership fee is all you pay for representation during the audit, appeal, Tax Court, and collection alternatives. If you need consultants, like forensic consultants, we pay for them. We are a one-stop shop. If you need all the benefits, choose the Full Protection plan. Otherwise, you can choose the IRS Guard Dog membership plan that works best for you and your budget.

If you do need the audit assistance, the out-of-pocket costs with Audit Defense membership can cost less than 20% of what it would cost you to hire all the experts you’ll need on your own. And we are good at this. Our success record speaks for itself. We have handled over 40 cryptocurrency audits with the IRS. (Although this number may not sound that large, most tax lawyers have handled at most a few crypto audits, and they charge $600 or more per hour!)

To get this amazing level of support, it’s a bit like buying car insurance for your tax returns. You need to have your membership in place before you get audited. Otherwise, if you join after you receive your audit letter, we’ll still help you, but benefits will be reduced and we will need to charge a hefty up-front retainer to help you out. You wouldn’t expect an insurance company to pay to repair your car if you sign up after you crash it, would you?

How can we deliver such a low price and great service?

We focus 100% on crypto reporting on tax returns. We only work with U.S. taxpayers, whether they live in the United States or worldwide. (We have clients in 71 countries who pay taxes to the U.S.)

We have in-house experts which helps to avoid the cost of outside consultants. Like professional football coaches, we study the IRS’ attack strategies. We know their weaknesses in handling crypto audits. That’s how we win for you. We know the game. And we can help you win!

Visit CryptoTaxAudit to learn more about our IRS Guard Dog membership plans.

DISCLAIMER: Opinions and perspectives of the author, host, and guests. It should not be construed as U.S. taxpayer advice. There are often multiple interpretations of tax law. Various strategies may be suited to specific individuals and for particular situations. Seek out professional tax, legal, or financial advice from CryptoTaxAudit or from other reputable companies.

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