The Shoebox Client: Deposits, Crypto, and an Undisclosed Foreign Account
Rosa, 44 and single, owns a nail salon as a sole proprietorship. For 2024 she brings a shoebox: bank statements showing $186,400 of deposits, a Square Form 1099-K for $41,200 (gross, before $1,644 of processing fees), and no expense records beyond $4,100 of canceled checks for supplies. She also hands you a Coinbase summary showing $9,300 of bitcoin sold during 2024 with no purchase records ("I just bought it here and there, and sometimes clients paid me in it"). She mentions a Mexican bank account she opened in 2016, still open, holding about $14,000 and earning nothing. She wants the return "done fast, same as last year." Her prior preparer reported only the 1099-K amount and told her the deposits were "none of the IRS's business."
1. Rosa instructs you to report only the $41,200 from the 1099-K and to leave the deposits alone. What are your professional obligations, and what do you do next?
Read the worked answer
You cannot prepare the return as instructed.
- Circular 230 §10.34(a): you may not sign a return you know, or reasonably should know, contains a position that lacks a reasonable basis or is an unreasonable position. The gap between $186,400 of deposits and $41,200 of reported receipts is a red flag, not a rounding error.
- §10.34(d) lets you rely in good faith on client information without verification only when the information appears reasonable and complete. It does not license ignoring facts you already hold in your hand.
- Preparer penalties: §6694(a) ($1,000) for an understatement from an unreasonable position; §6694(b) ($5,000) if willful or reckless; §6701 for aiding and abetting. The 1099-K and bank deposits also generate automated underreporter (CP2000) exposure.
Next steps: (1) Reconstruct gross receipts with a deposits analysis - total deposits, less non-income items such as transfers between her own accounts, loan proceeds, and owner contributions; (2) circularize her Square/processor statements and ask specifically about cash, Zelle, and Venmo receipts; (3) document every inquiry and her answers in the file; (4) report processor gross receipts on Schedule C line 1 and the $1,644 of fees as an expense rather than netting.
If she still refuses after you explain the consequences, decline to prepare the return and document the reason. §10.21 requires advising her of the noncompliance and its consequences but does not require you to prepare a return you believe is false.
2. Rosa has no records of what she paid for the bitcoin and no cost basis for the $9,300 of 2024 sales. How do you report this, and what else about the crypto must you explore?
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Reporting: each sale is a separately reportable capital transaction on Form 8949/Schedule D. Proceeds are $9,300; without substantiation the basis is zero, producing a $9,300 short- or long-term gain depending on the holding period. The burden of proving basis rests on the taxpayer; the §7491 shift of burden applies only after the taxpayer introduces credible evidence, which requires records.
Before defaulting to zero, make and document reasonable efforts: Coinbase downloaded transaction history/CSV, exchange emails, bank or card records showing purchases, and any wallet-to-wallet transfers. If part of the bitcoin was received as payment for salon services, that creates a second, more serious problem - ordinary income at the fair market value on the date received, with that same FMV becoming the basis. Ask how much, if any, came from clients and in what year.
Practical framing for the client:
- Zero basis is not a penalty, but it is usually the worst answer - reconstructing basis is almost always worth the effort.
- If she received crypto for services, Schrock-style barter/constructive-receipt rules make the income taxable in the year received, and Schedule C/SE tax may be due.
- Penalties and interest apply to unreported income in the year received, which may be an earlier year; note the statute of limitations implications.
Document the basis inquiry in the file whether or not she produces records.
3. Address the Mexican account and the prior preparer's work. What must you advise Rosa about filing obligations and about the earlier returns?
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FBAR. A U.S. person with a financial interest in foreign accounts whose aggregate value exceeds $10,000 at any point in the year must file FinCEN Form 114. One account at $14,000 meets the threshold. It is due April 15, 2025 (automatic extension to October 15, 2025), filed electronically through FinCEN's BSA E-Filing system - not with the IRS and not through the 1040 extension. Penalties are severe: a non-willful violation is inflation-adjusted and currently exceeds $10,000 per violation; willful violations run to the greater of roughly $100,000 (indexed) or 50% of the account balance, with criminal exposure for willful evasion. Non-willful conduct is still a penalty. She should also confirm the highest balance each year, since the account has existed since 2016.
Form 8938 (FATCA). Not required here: for an unmarried filer living in the U.S., the thresholds are $50,000 at year-end / $75,000 at any time, and $14,000 is below both.
Prior preparer's work. Under §10.21, advise her that the earlier returns appear to have understated income and explain the consequences. She is not automatically required to amend, but: the 3-year statute for refund claims and assessments, the 6-year statute where more than 25% of gross income was omitted, and the fact that an unfiled FBAR has no statute at all are all reasons to consider a voluntary correction. Reduce the decision and her instructions to writing.