The IRS uses computer systems to match information reported on your tax return against information provided to it by third parties. This includes information provided on Forms W-2, 1099-B, 1099-K, etc. The matching process is largely automated and if the computer finds a mismatch, it generates a notice to the taxpayer involved.
Typically, the notices issued are:
- CP2501: This is an initial notice issued in certain circumstances that alerts the taxpayer of a discrepancy between the information provided by third parties to the IRS and what was reported on the tax return. It does not propose any specific tax increase, but does provide information about the matching discrepancy so an individual can review their own records and respond. If not responded to, a CP2000 will be issued.
- CP2000: This is also a type of initial notice. It may be issued after a CP2501 or by itself without a CP2501 first. This notice also identifies the discrepancy between the information provided by third parties and what was reported on the tax return. Notably, this notice specifies what additional taxes and penalties the IRS believes are due as a result of the discrepancy.
- Letter 3219: This is a final notice that the IRS intends to assess additional taxes against a taxpayer based on the discrepancy. It is generally issued after a CP2000 where the IRS did not receive a response or the response was not adequate. A Letter 3219 includes with it the right to challenge the IRS’s decision in court. If this notice is not responded to, the IRS will assess the proposed taxes and penalties. Undoing that assessment can be a headache.
You should consider engaging the assistance of a tax professional to assist with responding to any of these notices. If you chose to respond yourself, we have provided some information below that will help you understand the IRS’s process and what information you want to review in crafting a response.
Please Note: If you receive a Letter 3219, it is advised that you speak to a tax professional as you do not want to forego any rights you might have to challenge the IRS’s decision in court.
Why am I getting this notice?
In the crypto space, some exchanges and platforms have been filing information returns with the IRS that report on cryptocurrency transactions you engaged in during the year. Due to a lack of clarity, these exchanges have been using two separate forms to do this reporting:
- Form 1099-K
- Form 1099-B
You are getting a CP Notice from the IRS relating to your crypto transactions because an exchange or platform you used provided information about your activity to the IRS and the IRS’s computer found a discrepancy.
If your exchange filed one of these forms with the IRS, you should also have received a copy of what was filed. If you ever receive one of these forms from an exchange during tax season, you should also ensure that the information shown on the form is reported on your tax return. This will minimize the risk of receiving a CP Notice in the future.
In both types of notices, you will see in the upper right corner of the first page which tax year the notice relates to.
Buried in the notice, there will be a section where the IRS identifies the specific discrepancy found by the computer system. It will state what type of form is involved, who the issuer of the form was, and the dollar reported on the form, resulting in the discrepancy. This is the information you will want to focus on to resolve the matter.
What do I need to do?
If you get a CP Notice, you should review the complete notice and identify what type of form is causing the discrepancy. The items you want to review differ slightly depending on which form is involved, so understanding the form involved is the first step.
Form 1099-K Issues
IRS Form 1099-K is typically used by businesses that accept electronic payments such as debit or credit cards, or Paypal. This form is generally issued by the processor of those payments to let the IRS know the amount of such payments processed during the year.
Certain crypto platforms use this form to report to the IRS the total amount of proceeds that you received from your sales or dispositions of crypto during a year. Unfortunately, Form 1099-K is not the best form for this type of reporting because:
- It aggregates proceeds amounts on a per month basis with no transaction-level detail.
- It does not include any information regarding your acquisition cost basis in the units that you disposed of.
- It generally relates to businesses that accept electronic payments, which means the IRS’s computer system tries to match the information from this form to a spot on your tax return that is likely different from where you reported your crypto trading transactions.
If the CP Notice you receive involves a Form 1099-K, then you need to verify a couple of things before responding to the IRS.
- Identify the issuer of the Form 1099-K and the amount that was reported. This will be included in the CP Notice.
- Review your transactions conducted at that exchange to verify that you think the amount on the Form 1099-K is correct.
- If you used TaxBit, review your TaxBit account or the Form 8949 generated using TaxBit for the tax year and exchange in question to see if the total gross proceeds amount exceeds the amount identified by the IRS as a discrepancy.
- Finally, review the tax return you filed with the IRS to ensure that information generated using your TaxBit account was properly reflected on the tax return you submitted to the IRS.
Form 1099-B Issues
IRS Form 1099-B is typically used by securities brokers to report the proceeds and cost basis for securities you sold or disposed of during a tax year. Unlike Form 1099-K, Form 1099-B reports information based on individual transactions.
Certain crypto platforms use this form to report to the IRS the amount of proceeds, and sometimes cost basis, for specific transactions involving the sale or disposition of crypto on the platform. Form 1099-B is a better form to report these transactions because:
- It provides details on the specific crypto asset and units sold.
- It provides the date of the sale.
- It provides the proceeds (in USD) generated from that sale.
- Where available, it provides the acquisition date of the units and the acquisition cost basis.
If the CP Notice you received involves a Form 1099-B, here are the things you will want to verify before responding to the IRS:
- Identify the issuer of the Form 1099-B—because Forms 1099-B received by the IRS are transaction specific, there may be multiple forms identified in the CP Notice with each one relating to a specific sale of crypto
- Check the transactions identified in the CP Notice against transactions you conducted on that exchange to verify that the Form 1099-B appears accurate; the easiest way to do this is by checking the transaction date as identified in the CP Notice and finding that same transaction in your exchange records.
- If you used TaxBit, verify whether the missing transactions are in your TaxBit account or on the Form 8949 you generated using TaxBit for the tax year and exchange in question to see if the proceeds amount was properly captured in your TaxBit account.
- Finally, even if the transaction information was properly captured in your TaxBit account and the transactions appeared on the Form 8949 generated using TaxBit, you still need to verify that those transactions were included as part of the Form 8949 that was submitted with your income tax return to the IRS.
CP Notices involving Forms 1099-B can be more time intensive because there may be multiple transactions identified as missing in the CP Notice, or they may include other discrepancies unrelated to crypto transactions.
If you filed a joint return, the CP Notice will include in the discrepancy information the social security number of the taxpayer involved in the transaction.
When reviewing Form 1099-B issues, you should look at the information on the CP Notice to see if the exchange reported your cost basis in addition to gross proceeds. Exchanges will always report gross proceeds from the sale or disposition of crypto to the IRS, but may or may not report cost basis. If cost basis was reported you will want to ensure that the cost basis you reported matches as well.
How do I respond to the IRS?
Once you have reviewed your records as described above, you should know if all of the transactions identified in the CP Notice were actually reported.
If all of the transactions were reported, then you should timely respond to the IRS following whatever instructions are contained in the CP Notice. Generally, a CP Notice will have a page that you can return where you indicate whether you agree or disagree with the IRS. You will want to include that page with your response indicating you disagree. In total, you should include:
- A cover letter from you to the IRS explaining your view of the situation. In your letter you should clearly indicate upfront that the transactions involved relate to virtual currency.
- A copy of any relevant pages from the CP Notice that you need to return.
- A copy of the Form or Forms 8949 that were actually filed with your income tax return with the transactions the IRS is asking about circled or highlighted so it is very easy for the IRS to match that submission against your original return and see that you properly reported everything.
If, after your review, you realize that some or all of the transactions the IRS is asking about are missing, you will need to submit a response identifying what was missing. With this submission you should include:
- A cover letter from you to the IRS explaining your view of the situation and that you discovered missing transactions. Your letter should clearly indicate upfront that the transactions involved relate to virtual currency.
- A copy of any relevant pages from the CP Notice that you need to return (indicating you only partially agree with their proposal).
- A copy of the Form or Forms 8949 that were actually filed with your income tax return. Label this copy “As Filed” and highlight or circle any of the transactions the IRS is asking about so they can see you reported those transactions accurately on your original tax return.
- A corrected copy of the Form or Forms 8949 that include the previously-missing transactions. Label this copy “As Corrected” and highlight or circle the additional transactions that were missing on the original form so the IRS can easily see that you added the extra transactions.
In order to generate the revised Form or Forms 8949 you may need the assistance of your tax preparer or the customer support function of any tax return preparation software you used to file your tax return.
If the transactions are in your TaxBit account, but are not populating on the Forms 8949 you generate using TaxBit software, contact TaxBit customer support.
Once you submit your response, it may take some time for the IRS to respond. If your submission acknowledges that you overlooked some transactions, the IRS will likely respond to you with a revised notice that recalculates whether any additional tax is due on those overlooked transactions.
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