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TPI misconceptions and IRS audit risks for crypto traders. The image features a dramatic night scene with a large, looming IRS gavel casting a shadow over stacks of coins bearing cryptocurrency symbols such as Bitcoin, Ethereum, and others. Business people are depicted climbing the coin stacks, reaching towards the moonlit sky, illustrating the high stakes and scrutiny in cryptocurrency taxation.

crypto tax audit Jan 28, 2024

Attention Cryptocurrency Traders: A Crucial IRS Tax Insight!

As a cryptocurrency trader, you're on the IRS's radar in a way you might not expect. It's widely known that individuals with incomes under $400,000 have a lower chance of an IRS audit. However, this figure predominantly relates to what we commonly understand as taxable income. Here’s where it gets particularly interesting for crypto enthusiasts: the IRS’s evaluation of Total Positive Income (TPI) plays by different rules, which could significantly impact your audit risk.

TPI takes a unique approach that is different from calculating standard taxable income. Instead of balancing your gains against losses, it sums up all positive income from trades, overlooking any subsequent losses. This method can create an inflated financial profile for active crypto traders. You might think you’re in the clear with minimal profits or losses, yet from the IRS's perspective, your TPI could inaccurately place you in a higher income bracket.

This inflated income picture can unintentionally trigger IRS attention. As a crypto trader, mastering the intricacies of TPI is essential. Knowing how it's calculated and its potential impact is crucial. This isn’t merely about staying compliant; it's also about smartly aligning your trading with a clear understanding of tax obligations, sidestepping unnecessary audits, and safeguarding your financial well-being in the ever-watchful eyes of the IRS.


A Closer Look at TPI in Crypto Trading

Understanding TPI is essential for cryptocurrency traders, especially considering the IRS's increased attention to high-income earners. Let’s take a typical example: a crypto trader starts with a portfolio of $20,000 USD and makes several trades throughout the year (figure 1).

Figure 1 - each time, the taxpayer trades 100% of his portfolio. This trader holds SOL at the end of the year.

Based on the trades, the taxpayer only makes $4,280 of taxable gains throughout the year. To the trader, this profit of $4,280 is relatively minor relative to the portfolio. However, the IRS views this differently when evaluating the taxpayer’s TPI. Just from the trades above, this taxpayer’s TPI is $736,630 - significantly over the $400,000 threshold.

Think of TPI as a taxpayer's total proceeds from trading plus all other gross taxable income such as wages, interest, dividends, and gross earnings from a business. In order to correctly calculate this taxpayer’s TPI, we need to add all those other amounts. Suppose the taxpayer makes $125,000 in W-2 wages while the taxpayer’s spouse makes $150,000. Adding these amounts to the $736,630 puts this taxpayer at $1,011,630 of TPI. 

As you can see, this couple may be under the impression that their taxable income is well below the $400,000 mark, which it is. However, when assessing the taxpayers’ TPI for audit purposes, they are over the $1M mark!

This situation underscores a vital distinction: TPI can significantly elevate a crypto trader's perceived income level, increasing their exposure to IRS scrutiny. This is because each time you trade, you are generating positive income, and when looking at TPI, this is the amount that matters, the total proceeds, not the taxable income.


Consequences for Crypto Traders

The implication of a high TPI for cryptocurrency traders is a significant concern. As the IRS sharpens its focus on individuals with higher incomes, those in the crypto market could find themselves facing increased scrutiny. The situation presents a peculiar challenge for active traders. Even when their actual taxable gains are minimal or non-existent, the sheer volume of their transactions can cumulatively push their TPI to levels that may attract unwanted attention from tax authorities.

This elevated TPI, stemming largely from the high turnover of trades rather than actual profit, could misclassify traders as higher-income earners. Such a scenario increases the probability of an audit as the IRS intensifies efforts to ensure compliance among those with higher earnings. It's an issue where the surface-level numbers don't accurately reflect the trader's financial reality. Regardless, these figures might initially guide IRS actions and put traders at an elevated audit risk.


Mitigating High TPI Risk

Addressing the risk associated with high TPI is essential for crypto traders. Effective strategies include diligent record-keeping of all transactions. This involves documenting every trade's details, such as dates, transaction amounts, digital asset types, and any other pertinent information. Do not assume that a centralized exchange will have the data available when needed; we have seen many of those fail or leave the US, making obtaining records difficult. Do not assume that you can simply recreate all your trades at a later time because they are on the blockchain; even blockchain explorers contain ambiguous data that, absent good records, you may find it difficult to substantiate your trades further down the line. Keep all emails and correspondence from exchanges and document each trade as you execute them. Such comprehensive record-keeping is key in illustrating the real nature of income, especially when TPI might paint a different picture.

Additionally, staying informed about the latest tax rules affecting cryptocurrency is imperative. Tax laws and guidelines in this sector are evolving, and what may be compliant today might change tomorrow. Understanding how different types of crypto transactions are viewed by tax authorities and how they affect both taxable income and TPI can guide traders in making decisions that align with compliance requirements.

 

Finally, accessing expert assistance is crucial. As specialists in cryptocurrency taxation, we at CryptoTaxAudit are equipped to offer in-depth guidance on managing Total Positive Income and comprehending the nuanced facets of crypto tax regulations. Our expertise is key in devising strategies that ensure you remain compliant while carefully structuring transactions to mitigate the risk of triggering IRS audits due to elevated TPI.


Staying Ahead of TPI Challenges

For cryptocurrency enthusiasts, effectively handling Total Positive Income (TPI) is essential. Active traders, in particular, should be aware of how their trading activity could inadvertently elevate their TPI and thus increase the likelihood of an audit. Seeking professional advice is critical for aligning trading practices with current tax laws, ensuring compliance, and reducing audit risks.

Act Now: Don’t wait for the IRS to come knocking. Assess your trading activity, understand your TPI, and take the necessary steps to align with IRS expectations. For personalized assistance, schedule a consultation today with CryptoTaxAudit for expert advice and peace of mind.

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