“We have information that you have or had one or more accounts containing virtual currency but may not have properly reported your transactions involving virtual currency, which include cryptocurrency and non-crypto virtual currencies.”

New IRS Notice 6174-A

The IRS clearly sees noncompliance on virtual currency transactions as a threat to the tax system. Now, the agency is starting to do something about it.

Starting in June, 2019, the IRS started sending notices to taxpayers and provide them an opportunity to voluntarily comply with not reporting their virtual currency transactions. The IRS describes the program as a “soft notice” alert to taxpayers to get them to voluntarily comply. A “soft notice” is defined as a notice that identifies a taxpayer as having potential noncompliance and requests them to voluntarily correct any misreporting (usually by filing an amended return). However, only one of the three new notices in this initial program are true “soft notices” – the other two have potential IRS enforcement.

In this program, the IRS has identified thousands of taxpayers who have cryptocurrency transactions and appear not to have reported them on their tax return. The IRS has not indicated how many taxpayers will get a notice for this initial phase. However, IRS officials have stated that the number of notices will be in the thousands – and likely “more than 10,000.”

The 3 new virtual currency notice programs

The IRS will be sending three different types of notices in the initial phase:

Letter 6174 – this is a soft notice informing the taxpayer that there is a likelihood that they did not report their virtual currency transactions. The notice asks them to check their return and, if necessary, file an amended return to correct the misreporting. The taxpayer is not required to respond to the notice and the IRS intends not to follow up on these notices. In short, this is information only to the taxpayer and education on how they comply.

Letter 6174-A – this is a “not so soft notice” from the IRS. As in Letter 6174, this letter tells the taxpayer that there is potential misreporting of virtual currency transactions. However, this notices states that the IRS may follow-up with future enforcement action. Again, no response is required if the taxpayer believes that they are in compliance. Taxpayers who receive this notice should be aware that they have been put on “notice” that they have been identified as a noncompliant taxpayer for potential future enforcement.

The last notice requires a response – Letter 6173 . This notice requests a response from the taxpayer about the alleged noncompliance. The letter provides instructions on responding to the IRS. The IRS intends to follow up on these responses to determine if the taxpayer is in compliance.

The IRS started sending a small number of these notices in June, 2019. Mass mailing of these letters will occur during the week of July 22, 2019, and continue through August. Taxpayers receiving this notice will have a special hotline and address at the IRS for any contacts and responses (see the notice).

Reacting to IRS soft notice programs

Soft notice programs are not new to taxpayers. The IRS usually uses soft notice programs for two reasons:

to put taxpayers on alert that they plan to start focusing on a certain area of noncompliance, and

to learn about the extent of noncompliance in that area.

In the case of virtual currency, the IRS is in its infancy stages of learning about taxpayer noncompliance and how to close the misreporting. The IRS clearly does not have the resources to audit all of these taxpayers and needs to understand how to best to achieve compliance.

The IRS knows that the goal is to get taxpayers to voluntarily comply. A soft notice program educates taxpayers and encourages voluntarily compliance without penalties. It also uses few IRS resources.

The IRS hopes that the long-term impact is to let taxpayers know that the IRS is watching – and has information that can potentially find and penalize taxpayers who do not properly report virtual currency transactions. And IRS studies show that third-party information and fear of audit are top drivers to getting taxpayers to voluntarily comply:

2018 IRS Study: Third-party information and fear of an audit highly influence taxpayer compliance behavior

Taxpayers who receive the new virtual currency notices should review their returns and file amended returns if needed. Taxpayers with Letter 6173 and 6174-A should provide a response to the IRS. Ignoring the notice may mean the worst of all possible scenarios: an IRS audit.