Protecting the Rights of Taxpayers Who Receive “Soft Letters” That

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Require Them to Provide Support for Their Return Positions and

Sworn Statements Outside an Examination

TAXPAYER RIGHTS IMPACTED

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The Right to Be Informed

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The Right to Privacy

OVERVIEW

The IRS’s use of “soft letters” to educate, inform, and encourage voluntary compliance is a useful

IRS compliance and enforcement tool. However, the IRS’s soft letters have been including language

aimed at compliant taxpayers that requires them to produce documents and a detailed supporting

statement signed under penalties of perjury. The soft letters, which may cover more than one tax

period, request information not included on a return and possibly cover years outside the statute of

limitations for assessment. The information requested is akin to an IRS examination but without

providing the taxpayer rights and protections afforded by an examination. One example of such a

soft letter request is for a taxpayer who had reportable virtual currency transactions (Letter 6173). It

is the National Taxpayer Advocate’s position that these intrusive requests violate taxpayers’ rights and

should not appear in any soft letters or communications outside the examination process.

DISCUSSION

Over the years, the IRS has issued taxpayers “soft letters” for a variety of issues and purposes,

including informing, educating, and encouraging voluntary compliance. However, the IRS

has recently begun using some soft letters as a means to bypass the rights and protections of the

examination procedures. One such example is Letter 6173, addressed to taxpayers with virtual

currency transactions.

The IRS requires taxpayers to report whether they received, sold, sent, exchanged, or otherwise

acquired any ﬁnancial interest in any virtual currency on their annual tax return.

The Large

Business and International (LB&I) Division has moved toward issue-based examinations and a

compliance campaign process. The taxability of virtual currency is one such campaign that LB&I

is focusing on in determining which taxpayers to select for examination.

In 2019, to combat virtual

currency abuses, the IRS sent letters to over 10,000 taxpayers who potentially failed to report income

and pay the resulting tax from virtual currency transactions or did not report their transactions

See Taxpayer Bill of Rights (TBOR), www.TaxpayerAdvocate.irs.gov/taxpayer-rights. The rights contained in the

TBOR are also codified in the IRC. See IRC § 7803(a)(3).

See IRS Form 1040, Schedule 1, used to file returns for tax year 2019.

IRS, IRS Announces the Identification and Selection of Five Large Business and International Compliance

Campaigns, IRS News Release (July 2, 2018), https://www.irs.gov/businesses/irs-announces-the-identification-

and-selection-of-five-large-business-and-international-compliance-campaigns.

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properly.

Although we applaud the IRS’s efforts involving virtual currency abuses, including

increased use of data analytics, we do not believe the IRS should include compliant taxpayers in its

soft letter campaign. Currently, there are three virtual currency letter variations: Letter 6173, Letter

6174, and Letter 6174-A.

It is the IRS’s position that soft letters come in many varieties, tailored to the sophistication of the

audience and issue(s) involved. Each letter speciﬁes options for taxpayer action, if appropriate.

Some letters merely inform the taxpayer that the IRS has observed certain information about them

and highlights relevant law. The stronger letters result from observations suggesting higher risk

of non-compliance on the part of the recipient and urge the taxpayer to respond by a speciﬁc date

(e.g., ﬁle an amended return or statement under oath) or risk further action by the IRS. None of

these soft letters constitute the start of an examination, but the response, or lack thereof, will factor

into the IRS’s next steps intended to bring taxpayers into compliance. The IRS contends that soft

letters are a service to the taxpayers who receive them because they are offered an opportunity to

comply if they have not or to avoid an examination if they have complied, and it is a service to the

broader taxpayer community as reporting and paying compliance increase, thus improving fairness

to all. Soft letters may be a useful tool in educating taxpayers and may assist in future compliance.

However, as drafted, Letter 6173 is not such a letter and crosses over from educating to imposing

onerous taxpayer production burdens outside the arena of an examination.

Compliant Taxpayers

What is disturbing about soft Letter 6173 is that it speciﬁcally addresses taxpayers who believe they

are compliant and imposes unreasonable burdens on them outside the protection of an examination.

The IRS has stated that Letter 6173 is not an examination and therefore the IRS is not required to

follow the examination guidance or provide taxpayers the rights afforded them in an examination.

Yet, Letter 6173 fails to inform taxpayers that the letter is not part of an examination and as written

appears to be a threat directed at taxpayers who believe they are compliant.

Speciﬁcally, for the taxable years 2013 through 2017, the letter instructs taxpayers as follows:

If you believe you followed all tax and information reporting requirements relating

to your virtual currency accounts, mail or eFax the following to the address or eFax

number shown at the top of this letter.

- A statement of facts explaining your position. Include a complete history of

previously reported income from your virtual currency transactions. Explain

the actions you took to become compliant with U.S. reporting requirements and

provide copies of previously ﬁled documents that conﬁrm your compliance.

IRS, IR-2019-132, IRS Has Begun Sending Letters to Virtual Currency Owners Advising Them to Pay Back Taxes,

File Amended Returns; Part of Agency’s Larger Efforts (July 26, 2019), https://www.irs.gov/newsroom/irs-has-

begun-sending-letters-to-virtual-currency-owners-advising-them-to-pay-back-taxes-file-amended-returns-part-of-

agencys-larger-efforts.

See, e.g., IRC § 7605(b) (prohibiting unnecessary or repetitive examinations). See also IRS Pub. 3498, The

Examination Process (explaining the examination process and taxpayers’ rights before, during, and after an

examination). Letter 6173 is not the only IRS letter that solicits an explanation from taxpayers who believe they

complied with filing requirements. IRS Letter 6290 contains a similar request with respect to compliance with the

Foreign Account Tax Compliance Act. LB&I declined to remove the request from Letter 6290.

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- Your contact information, including your telephone number, complete address,

and the address where you receive mail (if different).

- The following statements with your signature and date:

I, , declare under penalties of perjury that I have examined this entire

document, including all attachments and accompanying statements, and that the

enclosed is true, correct, and complete.

I also understand with respect to any submission that the IRS reserves the right

to make further contacts with me and my representatives to clarify any written

explanation or any other documents. Statements and documents sent under this

option will be checked against information received from banks, ﬁnancial advisors,

and other sources for accuracy.

The letter instructs and demands that these taxpayers produce documents, together with written

factual and legal support for a ﬁve-year period. Depending upon the taxpayer’s speciﬁc facts and

the date of the letter’s issuance for some of these years the three-year assessment period may have

closed.

It should be noted that the IRS has not required the above information to be provided on a

tax return. Yet, the soft letter is requiring it. This request is what normally happens during an IRS

examination but with the numerous procedural protections of an examination. The Code, Congress,

and the IRS have repeatedly acknowledged taxpayers’ rights and protections, and this letter not only

does not provide them — it undermines them.

The request for an explanation made outside the audit process burdens taxpayers who believe they

are compliant and undermines their rights to be informed and to privacy, which includes the right to

expect that any IRS inquiry will be no more intrusive than necessary.

Moreover, the taxpayer may

ﬁnd it necessary to hire representation to review his or her records to provide a complete response

and then still be subject to an examination later, long after the taxpayer’s response, for which the

taxpayer may again need representation. Letter 6173 is not consistent with the protections afforded

taxpayers.

The request for a sworn written statement should be removed from Letter 6173.

Non-Compliant Taxpayers

Letter 6173, like Letters 6174 and 6174-A, also addresses taxpayers who may have failed to include

virtual currency on their return or who incorrectly reported the appropriate virtual currency tax

consequences. The letters encourage the taxpayer to ﬁle an amended return or ﬁle a delinquent

return. The letters fail to provide taxpayers with information about the application or assertion

of penalties or interest should they ignore — or follow — this encouragement. Although the

Code does not require taxpayers to ﬁle an amended return, it does encourage taxpayers to correct

any incorrect positions set forth on the original return. One such encouragement is the ability to

ﬁle a qualiﬁed amended return (QAR) that prevents the IRS from assessing the accuracy-related

See IRC § 6501.

TBOR, www.TaxpayerAdvocate.irs.gov/taxpayer-rights.

LB&I declined TAS’s recommendation to remove the request that compliant taxpayers provide additional

information under a sworn statement from Letter 6173.

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penalty.

A QAR is an amended return that corrects an error in a previously ﬁled return prior to

the IRS contacting the taxpayer regarding an examination of the return.

One question that arises

is whether after sending Letters 6173, 6174, or 6174-A and then opening an examination, the IRS

will contend the letters, although they are not examinations when sent, are a contact regarding an

examination of a return, making the taxpayer ineligible for relief from the 20 percent accuracy-

related penalty by ﬁling an amended return.

Another challenge with QARs is the exclusion for amended returns ﬁled after the issuance of a John

Doe summons.

If the recipients of Letters 6173, 6174, or 6174-A were identiﬁed pursuant to a

John Doe summons, they are ineligible for QAR penalty relief.

The letters do not provide that

information to the taxpayer. As a result, taxpayers may be subject to penalties even if they correct

their returns before the IRS opens an examination.

OBJECTIVES FOR FISCAL YEAR 2021

In ﬁscal year 2021, TAS will:

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Continue to work with LB&I toward removing burdens imposed on taxpayers who believe they

are compliant resulting from soft letters such as Letter 6173;

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Work with the IRS and encourage guidance allowing accuracy-related penalty relief when ﬁling

a virtual currency amended return in response to Letters 6173, 6174, and 6174-A;

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Encourage the IRS to offer a positive incentive for taxpayers who receive Letters 6173, 6174,

and 6174-A to disclose and correct errors by developing an administrative program for virtual

currency reporting issues similar to the offshore disclosure initiatives to encourage voluntary

compliance; and

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Work with the IRS on future soft letters to eliminate burdens on taxpayers by protecting their

rights.

See IRC § 6662(d)(2)(B); Treas. Reg. § 1.6662-4(f).

See Treas. Reg. § 1.6664-2(c)(3)(i)(A), which includes in the definition of “qualified amended return” an amended

return filed before the taxpayer is first contacted by the IRS concerning any examination with respect to the return.

See IRC § 6662(a).

See Treas. Reg. § 1.6664-2(c)(3)(i)(D) and (c)(5), Examples 5 and 6.

See Robert W. Wood and Joshua D. Smeltzer, IRS Prepares for Battle on Cryptocurrency Reporting, 166 Tax NoTes

Federal 601 (Jan. 27, 2020), which describes a John Doe summons issued to Coinbase that resulted in the

release of information about 13,000 Coinbase customers.