If you have received IRS Letter 672C, the agency is telling you that third-party data, usually from a crypto exchange or a foreign financial institution, does not match what you reported on your tax return. The letter is not an audit and does not propose a specific tax bill, but it is the step that comes right before one. To respond to IRS Letter 672C, you need to read the deadline on the letter, pull the records behind the income the IRS thinks you missed, decide whether your original return was wrong, and either explain why it was correct or file amended returns before the window closes. Done right, this is the cheapest moment in the process. Done late or not at all, it becomes an examination, and the penalty exposure gets steep fast.
What the Letter Actually Is
Letter 672C is a pre-examination contact. The IRS has information suggesting you underreported income and is giving you a chance to review your return and correct it voluntarily before the agency commits examination resources to your case. It is not a Notice of Deficiency, which formally proposes additional tax and starts the 90-day clock to petition Tax Court. It is also not a CP2000, which shows line-by-line adjustments the IRS has already calculated. Letter 672C is more open-ended: a flag, a deadline, and an invitation to fix the problem on your terms.1Internal Revenue Service. Understanding Your IRS Notice or Letter
These letters go out in bulk as part of targeted compliance campaigns, with virtual currency and offshore accounts among the most active areas.2Internal Revenue Service. Large Business and International Active Campaigns The IRS already has data it believes contradicts your return. Your job is to show either that the data is wrong, that your return was right, or that you are correcting it now.
Read the Deadline and Protect It
Your letter prints a response deadline, a mailing address, a control number, and a phone number for the unit handling your case. The control number is what routes anything you send back into the right file, so copy it onto every page of your reply.
If you cannot assemble a complete response in time, call the phone number on the letter before the original deadline passes and request an extension. The IRS will generally grant another 30 days if you ask before the window closes. Silence is the one response that reliably makes things worse: if the IRS hears nothing, your case can be escalated to a formal examination or eventually to a statutory Notice of Deficiency.
Send everything by certified mail with return receipt requested. If timeliness is ever disputed, you want proof of when the IRS received your package, not just when you dropped it in the mail.
Figure Out What the IRS Is Flagging
Letter 672C does not always spell out the exact transaction the agency is matching against. In most current cases, the trigger is one of two things.
Digital Asset Transactions
The IRS treats digital assets, including cryptocurrency and NFTs, as property. Every sale, trade, or exchange is a taxable event.3Internal Revenue Service. Frequently Asked Questions on Digital Asset Transactions If you bought Bitcoin for $5,000 and later swapped it for Ethereum worth $15,000, you owe tax on the $10,000 gain even though you never touched dollars. Many taxpayers miss this because crypto-to-crypto trades do not feel like sales.
The reporting pipeline into the IRS has tightened. Starting in 2025, brokers must report gross proceeds from digital asset transactions on the new Form 1099-DA, and starting in 2026 they must also report cost basis for assets acquired after 2025.4Internal Revenue Service. Final Regulations and Related IRS Guidance for Reporting by Brokers on Sales and Exchanges of Digital Assets If an exchange reported sales to the IRS that are not on your return, Letter 672C is the predictable follow-up.
Foreign Accounts and Assets
The other common trigger is unreported foreign financial accounts or assets. Two separate obligations apply, and missing either can prompt a letter.
The FBAR (FinCEN Form 114) is required if the combined value of all your foreign financial accounts exceeds $10,000 at any point during the year. It is filed electronically with FinCEN, not with your tax return.5Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR)
Form 8938, under FATCA, is filed with your return. For U.S. residents filing single or married filing separately, it is required when specified foreign financial assets exceed $50,000 on the last day of the year or $75,000 at any point. Married filing jointly thresholds are $100,000 year-end or $150,000 at any time, and taxpayers living abroad face higher thresholds.6Internal Revenue Service. Do I Need to File Form 8938, Statement of Specified Foreign Financial Assets The IRS receives foreign account data through FATCA information-exchange agreements, so an overseas account is not invisible.
Pull Your Records
Before you decide how to respond, you need the underlying numbers.
For crypto, download complete transaction histories from every exchange and wallet you used in the tax years at issue. For each disposition, you need the acquisition date, the cost basis, the disposition date, and the proceeds. Your gain or loss is the difference. Cost basis is where most crypto cases are won or lost: if you cannot document what you paid, the IRS may treat the entire sale proceeds as gain. Wallet addresses, exchange account records, and blockchain transaction IDs all help prove you actually paid something before selling. Holding period matters too, because assets held longer than a year qualify for long-term capital gains rates. Crypto dispositions get reported on Form 8949 and summarized on Schedule D.7Internal Revenue Service. Instructions for Form 8949 (2025)
For foreign accounts, pull statements for every account for each year in question. You need the peak balance during the year for FBAR purposes, not the year-end balance, along with records of any interest, dividends, or capital gains the accounts produced. That income belongs on your Form 1040 whether or not you repatriated it. If you filed FBARs or Forms 8938 in prior years, locate those too, so you can pinpoint exactly which accounts or assets slipped through.
File Amended Returns, Tied to the Letter
If your review confirms you underreported, file Form 1040-X for each affected tax year. Each year gets its own 1040-X, and you can file electronically or on paper.8Internal Revenue Service. Instructions for Form 1040-X (Rev. December 2025) Show the original figures, the changes, and the corrected figures. Attach the supporting schedules the correction requires: an updated Form 8949 and Schedule D for crypto, an updated Form 8938 for foreign assets. Pay any additional tax with the amended return. Interest runs from the original due date, so delay is expensive.
Include a cover letter referencing the Letter 672C control number, explaining what you corrected, and listing enclosures. That cover letter is what connects your amended returns to the open compliance inquiry instead of letting them drift into general processing.
Consider Streamlined Procedures Before You File
If your unreported income involves foreign financial assets and your failure to report was not willful, filing straight amended returns may be the wrong move. The IRS Streamlined Filing Compliance Procedures are built for taxpayers whose noncompliance was due to negligence, inadvertence, mistake, or a good-faith misunderstanding, and the terms can be dramatically better than simply amending.9Internal Revenue Service. Streamlined Filing Compliance Procedures
Two tracks exist. If you live outside the U.S. and meet the foreign residency test, the Streamlined Foreign Offshore Procedures waive all penalties. If you live in the U.S., the Streamlined Domestic Offshore Procedures charge a 5% miscellaneous offshore penalty on the highest aggregate balance of your unreported foreign accounts during the compliance period.10Internal Revenue Service. Streamlined Filing Compliance Procedures for U.S. Taxpayers Residing in the United States Frequently Asked Questions and Answers Either way, you still owe back taxes and interest.
There is a critical eligibility rule: once the IRS has initiated a civil examination of any of your returns, streamlined is off the table.9Internal Revenue Service. Streamlined Filing Compliance Procedures Letter 672C is a pre-examination contact, so it does not automatically disqualify you, but if the agency escalates, that door shuts. This is a reason to move fast and to get advice before you start sending amended returns on your own.
What You Are Exposed To if You Do Nothing
The penalty stack behind an unreported income case is layered, and understanding it is what makes the response deadline feel appropriately urgent.
The baseline is the accuracy-related penalty: 20% of the underpayment attributable to negligence or disregard of tax rules.11Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments For most forgotten crypto transactions, this is the tier the IRS will reach for.
If the IRS determines the failure to report was intentional, the civil fraud penalty is 75% of the portion of the underpayment attributable to fraud.12Office of the Law Revision Counsel. 26 USC 6663 – Imposition of Fraud Penalty The IRS bears the burden of proving fraud, and the fraud penalty replaces rather than stacks on the 20% accuracy penalty on the same dollars.
FBAR penalties sit on top of any income tax penalties and have their own statutory structure. The base amounts are $10,000 for non-willful violations and the greater of $100,000 or 50% of the account balance for willful violations.13Office of the Law Revision Counsel. 31 USC 5321 – Civil Penalties These adjust annually for inflation; the 2025 maximums are $16,536 per non-willful violation and $165,353 (or 50% of the balance, whichever is greater) for willful.14eCFR. 31 CFR 1010.821 – Penalty Adjustment and Table
Interest runs on top of all of it, from the original due date of the return, and it compounds daily. On returns several years old, interest alone adds a meaningful amount to the bill.
Reasonable Cause if Penalties Hit
Penalties are not automatic even when the underlying tax is owed. No accuracy-related or fraud penalty applies to any portion of an underpayment if you can show reasonable cause and good faith.15Office of the Law Revision Counsel. 26 USC 6664 – Definitions and Special Rules A parallel reasonable cause exception exists for non-willful FBAR penalties when the account balance was otherwise properly reported.13Office of the Law Revision Counsel. 31 USC 5321 – Civil Penalties
There is no bright-line definition. Factors that help include reliance on professional advice, the complexity of the reporting rule, and evidence of an honest effort to comply. A taxpayer who asked a CPA about foreign account reporting and got the wrong answer is in a far better position than one who never looked at the question. Document anything that supports good faith, because this defense can wipe out or reduce penalties even when the tax itself is owed.
How Many Years Can the IRS Reach Back
Letter 672C may reference several prior years, and the statute of limitations is what defines the outer edge. The general rule is three years from the date you filed the return.16Office of the Law Revision Counsel. 26 USC 6501 – Limitations on Assessment and Collection Three exceptions matter here:
- Six years if you omitted more than 25% of your gross income, or if the omission exceeds $5,000 and relates to a foreign financial asset reportable under FATCA.
- No time limit at all if the IRS establishes the return was fraudulent with intent to evade tax.
- No time limit if you never filed a return for the year, because the assessment clock never starts.
The foreign asset exception bites hard. Even a small omission of foreign-source income can open the six-year window if it is tied to assets that should have appeared on Form 8938. That is why compliance letters built on offshore data often reach back further than taxpayers expect.
Get Representation if the Numbers Are Serious
You have the right to challenge the IRS’s position, submit documentation, and be heard. You also have the right to appeal most IRS decisions to the Independent Office of Appeals before any court filing. And you have the right to have someone else handle the whole thing. To authorize a CPA, enrolled agent, or tax attorney to deal with the IRS on your behalf, file Form 2848, Power of Attorney and Declaration of Representative.17Internal Revenue Service. About Form 2848, Power of Attorney and Declaration of Representative Once it is on file, your representative can receive notices, respond, negotiate, and pull your account transcripts. If you cannot afford a professional, the Taxpayer Advocate Service can refer you to a Low Income Taxpayer Clinic.
For crypto cases with messy cost basis or foreign accounts with FBAR exposure, representation generally pays for itself. The penalty math on offshore cases alone can run many multiples of a professional’s fee, and someone who works these matters routinely will know whether streamlined is still available, what reasonable cause arguments actually land, and how to present the case so the agency does not reach for the harsher penalty tiers.