You can’t outrun the long arm of the US Internal Revenue Service (IRS.)

But some are trying or might try and that’s a bad idea, according to Sean Ryan, CTO of NODE40.

As has been reported in the media, some cryptocurrency investors are receiving a new round of letters from the IRS telling them that their tax returns don’t match the information received from virtual currency exchanges. Ryan says these CP2000 letters have much more serious consequences for crypto investors, more so than the informational letters sent a couple of weeks ago.

“The thing that people don’t understand about these CP2000s is that it is generated off the reporting from exchanges,” Ryan begins. “Unless cryptocurrency investors are operating solely on the exchange, which is unlikely, then it is not surprising that there is a discrepancy.”

What has been happening though, he explained, is that many of the investors who received a 1099-K form from the exchange realized it was incorrect, so they paid what they thought they needed to pay based on their own evaluation of their liability. Once that happens a discrepancy emerges and once that goes through the IRS algorithm, if what the taxpayer pays is different from what the IRS expected, based on what the exchange is reporting you are going to end up with this CP2000 letter saying you have a problem.

“The implication of this is far reaching. Every year the IRS is required to produce the Electronic Tax Administration Advisory Committee Report and submit it to Congress,” Ryan said. “I’ve gone back through the last 6 years of these reports looking for any information on CP2000 letters and the last time the IRS did an internal survey or audit of their own data was in 2014. Based on this data, I estimate that ~100,000 people have recently received CP2000 letters, based on the number of 1099-Ks the IRS has received from exchanges, brokers or anyone required to report 1099-Ks in the last five years.”

This has very serious implications for crypto investors too, Ryan said. “If you, as a taxpayer receive one of these CP letters and you don’t fix the taxes that you owe or you don’t write in and prove tax return items within 30 days of receiving the letter, the IRS can tell the exchange to start holding back (backup withholding) part of the money you would be withdrawing from that exchange.”

The rate from 2018 onwards is 24%.

Here’s an example – if an investor has a $10,000 loss on the exchange. He withdraws $100,000 resulting in a $10,000 loss, so he should be taking a loss, but the IRS sees that as a $100,000 payment. If the reason the trader was taking that out was to pay taxes, now with backup withholding, the IRS is going to take 24% out of that, so $24,000. And they have a right to do so, but that money is not actually owed.

In other words, pay your taxes before the IRS does it for you.