How to avoid common crypto tax mistakes
Are you considering getting into cryptocurrency? Getting it right on tax returns can be a tedious and frustrating process. Crypto venues are likely scattered across many different platforms and exchanges. This makes it difficult to aggregate all this data.
The Internal Revenue Service is familiar with the fact that millions of cryptocurrency transactions may not be reported yet. Contributors may think they won’t get caught. Additionaly, many Coinbase users may have thought their information would be protected until proven otherwise. The best method to get rid of penalties is to uncover and report as precisely as possible. Prove that you did not deliberately intend to avoid taxes.
Otherwise, you could face heavy penalties and even a possible criminal investigation. Anyone convicted of tax avoidance, for example, can face up to five years in prison and a fine reaching $250,000. Taxpayers might believe that the IRS could penalize them. However, they can assume they don’t need to worry about criminal implications.
Recent IRS actions
Taxpayers should remember recent actions by the Internal Revenue Service regarding criminal referrals. IRS commissioners have taken action indicating a potential increase in the number of criminal investigations. Besides, they were recently asked to lead the small business division of the IRS.
The IRS is also taking steps to build cases against taxpayers who don’t report cryptocurrencies. The IRS recently issued a draft of the 2019 Form 1040 containing a question directed at cryptocurrency. A checkbox in Exhibit 1 requires taxpayers to respond if at any time during 2019 they sold, sent, traded, or acquired any financial interest in cryptocurrencies.
The Department of Justice’s Tax Division has argued that failure to check a box, in the context of reporting foreign bank accounts, is willfulness. Intentional failures, as opposed to unintentional actions, carry higher penalties and a more significant threat of criminal investigation.
What is the general treatment of cryptocurrency?
According to Notice 2014-21, cryptocurrency is not a currency for tax purposes but instead property. Since cryptocurrency is regarded as property, taxpayers pay taxes if they profit, but they can also claim losses. As property, taxpayers need to know when they bought the cryptocurrency, how much they paid, and what they received for it.
IRS guidance indicates that determination of the basis is the fair market value of the virtual currency, in US dollars, after the recieval of the virtual currency. If the taxpayer receives the virtual currency from an established exchange, the value could be easily determined. However, if the cryptocurrency was received through peer-to-peer transactions or it has no published value, it can be more difficult. The IRS still demands taxpayers to apply some reasonable method to value cryptocurrency and establish that such value is accurate.
How Taxpayers should manage cryptocurrencies
Cryptocurrency investors mining cryptocurrencies may have other problems. For one thing, they may have trouble figuring out exactly when they received the mined cryptocurrency to determine its value for reporting purposes. IRS guidance says taxpayers should use a reasonable method of determining the fair market value used to determine profit or loss.
Taxpayers may use a FIFO (first in, first out) or some other method as long as applied consistently. If taxpayers are not prone to keeping records, They would necessitate alternative strategies for past transactions.
As cryptocurrencies become more common in the market, their use will branch out to purchasing items or services. However, because the cryptocurrency is seen as property, each exchange can generate profit or loss. Taxpayers using cryptocurrencies for small purchases could have multiple small reportable gains and losses that need recording, reporting, and accounting throughout the year.
Remaining uncertainties from cryptocurrency reporting
More generally, of course, even with recent guidance from the IRS, important questions remain. The current guide and FAQs do not specifically address how to calculate the value, how to determine base, or how wealth tax rules apply to cryptocurrencies. Of course, the FAQ is not technically a legal authority that taxpayers can trust. Because of many of such issues taxpayers believe reporting properly will assist them bypass penalties.
Still, the new guide includes the 2019-24 Revenue Rule, in addition to the expanded FAQ. This new revenue rule addresses common questions from taxpayers and tax professionals regarding the tax treatment of cryptocurrency hard forks and air deliveries. At the moment, the safest path seems to be through careful reporting, with amendments and reports from the past. In some cases, regular amended statements or discreet disclosures may be acceptable.
At other times, formal voluntary disclosures to the IRS may be relevant. In any circumstance, it seems reasonable to do as much as possible with the current guide, remaining open to the possibility of corrections later in case of a new guide. The IRS response to cryptocurrencies for the past five years has not been perfect. But there can be no question about the IRS’s intent to run considerable revenue and compliance campaigns in this happy new world.
Common crypto tax mistakes to avoid
- “Airdrops, forks, and splits” have tax implications, and it is essential to become familiar with them quickly. If you are using encryption software to generate your tax returns automatically, you must show the software how you acquired these tokens. If you don’t classify them as forked/airdropped coins, it will feel like they came out of nowhere in your account or wallet. Later, when you exchange or sell these currencies, the registry will alert you that you are trying to sell something you do not own.
- Transactions like exchanging a car for crypto, recieving payment in cryptocurrency, investing in crypto, or mining crypto may require a different IRS form.
- Cryptocurrency received as earned income is not taxed the same as the sales of crypto held for investment.
- It’s essential to understand the tax implications if you are thinking of exchanging crypto for Goods and Services.
- Taxpayers must maintain adequate records reflecting crypto transactions to determine the gain or loss and resulting tax due.
- If you do not include your income data, there will be inaccuracies in your tax returns. However, many crypto investors don’t realize that they can save money by filing their crypto taxes if they incur losses.