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Image showcasing a smartphone with crypto icons, a report titled 'CHANCE' with upward arrows symbolizing audit risk, and a person's hand holding a pencil, alongside a cup of coffee, indicating strategic planning for IRS audit risk management in the crypto trading space.

audit cryptocurrency audit defense May 17, 2023

What makes you a target of an IRS audit? And what can you do right now to protect yourself as a crypto trader or investor today?

Are you worried about an IRS audit?

Are you up at night worrying if the IRS coming after you? Whether you reporting your crypto gains correctly?  Or what the odds are of you being audited and having your life turned upside down?

Crypto traders may owe $1 trillion in tax.

The IRS Commissioner claims that there are over $1 trillion in taxes which have not been reported or paid. He blamed crypto traders for that. Yes, the IRS vilified all crypto traders. And they got their wish of more money from Congress to pursue their plans.

What is the IRS doing about it?

In May 2022, the IRS published some special statistics about audit rates to quell complaints from Congress. The IRS statistics express audit rates in terms of Total Positive Income (TPI). This is very different from AGI, or Adjusted Gross Income, which most taxpayers think about when reporting their taxes. Here’s why.

What is your Total Positive Income?

The IRS defines TPI as income without expenses. This is the figure to be concerned about when it comes to IRS audits.

TPI calculation example 1.

If you actively trade cryptocurrencies, whenever you exchange crypto for something else (another crypto, stablecoin, or fiat), the value of that sale is called the “proceeds.” The cost of the transaction doesn’t matter.

The cumulative total of all your proceeds is calculated as the amount of Total Positive Income. If you are a high-frequency trader, your TPI could be enormous. That’s true even if you had a net loss for the year, because TPI is always a positive number.

An example showing it you start with $10,000 at the beginning of the year and trade trade for only $1 more each week, you will have a total of $10,052 in your account yet have a Total Positive Income (TPI) of $521,326, the number the IRS uses as one of their primary audit selection criteria.

TPI calculation example 2.

If you have home-business selling goods on Amazon. If during the year your revenue was $300,000, regardless of whether you made a profit or loss for the year, your TPI was $300,000. That’s true even if your AGI may calculate to be $0.

Most of our crypto tax preparation clients have a TPI greater than $1 million and many of them have a value over $10 million. We even have clients with TPI in the $100s of millions! Yet, that is not the same as their gains from crypto trading.

A table showing various Total Positive Income (TPI) value ranges and the corresponding chance of an IRS audit based on data provided by the IRS and when extrapolating the likelihood of being selected for an IRS audit over a 6-year period.

High audit rates.

The IRS statistics show very high audit rates. These are the chances of getting audited for 2019 only. The third column extrapolates these chances over a six-year period.

These fresh audit rates reflect the IRS’ commitment to Congress to dramatically ramp up audits on the wealth. It is easier for the IRS to shakedown crypto traders than the ultra-rich, who can use a phalanx of lawyers to confuse the IRS.

Is six years a long time?

The IRS gets six years after filing to audit a return if they can show you underreported your income by 25%. Otherwise, they only get three years to audit you. Because of the high TPI numbers, the six-year window is easy for the IRS to hit.

If the return is fraudulent (such as answering “No” to the digital asset question on Form 1040), then there is no time limit. If you reported only some, or none, of your crypto income, then you have no protection at all. There is no statute of limitations in that case.

These rates do not include “CP2000 examinations”, which the National Taxpayer Advocate has called “unreal audits”. These CP2000 examinations occur several times higher than the audit rates.

How does the IRS know my TPI?

The IRS learns what Total Positive Income you have from three primary sources:

  • Crypto exchanges file Form 1099 with the IRS to report the income you received on their exchanges. This is not just fiat payouts of USD. This includes all trades.
  • Court summons to crypto exchanges operating in the U.S. This catches those exchanges that don’t file Form 1099.
  • Other taxable income is reported by an employer (Form W-2) or other payers (1099 and K-1).

What’s the solution?

If your report more TPI on your return than the IRS was expecting, that’s good. The IRS shouldn’t bother you.

Reduce your risk of an audit.

There are many ways to reduce your risk of audit besides reducing your Total Positive Income. Learn more at CryptoTaxAudit, the crypto tax and IRS audit experts.

Protect yourself today.

CryptoTaxAudit offers a proactive membership called IRS Guard Dog. It protects you in the event of an audit. It includes monitoring, advisory, representation, and defense benefits. Learn more today.

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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