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.

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. 

Ignore the CP2501 letter you received, and it will get much worse

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.

Do not call the IRS. Currently, they only answer the phone less than 10% of the time. [1] 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 fail to recalculate all your crypto capital gains nor claim all your losses, rug pulls, scams, and abandoned tokens

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!

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.

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 on someone else’s case.

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.

Cryptocurrency audits are always considered complex to audit, appeal, and litigate at 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.

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.