Cryptocurrencies (also called altcoins or virtual currency) have seen some wild fluctuations in the recent past. For example, the value of a single full Bitcoin went from $10,000 to nearly $70,000 and then back down to $20,000, all within the span of two years.
Some people have realized huge profits and others have lost thousands (or more), but not everyone has considered the tax ramifications of those sales. The Internal Revenue Service considers cryptocurrencies to be property. That means a variety of taxes likely apply to your altcoin transactions, whether you sell your virtual currencies or use them to pay for goods or services.
Figuring out crypto taxes can be a little more complicated than your average stock or forex market sales, so if you sold or exchanged any digital currencies you may want to consult a tax professional to make sure you stay in the good graces of the IRS.
Failing to report these sales on your tax return is fraud, and with the IRS taking a closer look at who has profited from crypto, you don’t want to be caught on the wrong side of the tax law. Even if you have filed past returns that omitted virtual currency profits, it’s better to amend them now than wait for the IRS to flag you for an audit or assess financial interest and penalties against you for underreporting.
You may even be charged with criminal activity if you’ve knowingly failed to report digital currency transactions on your tax return.
How Will My Cryptocurrency Earnings Affect My Taxes?
When virtual currency first became popular, one of the big draws was the supposed anonymity and lack of regulation. However, as crypto values increased exponentially, the IRS began to regulate tax obligations for crypto transactions. Most recently, the IRS has added reporting requirements for crypto exchanges (such as Coinbase).
You will need to provide personal information, including your Social Security number, so that the exchange can report your transactions to the IRS and send you a 1099-K form. This will start in tax year 2023, but exchange platforms may already be asking for you to verify your identity for reporting purposes.
Even if you haven’t received a 1099 in recent years, you are still on the hook for taxes on virtual currency transactions. The IRS has stated that cryptocurrency is treated as property, which means if you sell or exchange your virtual currency for a profit within a year of buying or receiving it, the gains count as taxable income. If you’ve held for over a year, then your gains or losses are taxed as capital gains or losses.
Let’s examine the tax implications for different types of cryptocurrency transactions:
- Initial offerings: Considered income for both individuals and businesses
- Trading: Results in either capital gains or losses; tax loss harvesting could offset capital gains and minimize tax liability
- Exchanging: Altcoin exchanges are treated as a sale that results in either capital gains or losses.
- Receiving payments: Virtual currency payments received as salary or in exchange for a product or service are considered income.
- Air drops: The day of the drop, these transactions are treated as ordinary income, but their value will vary and will be considered a capital gain or loss when sold or exchanged.
- Mining: Considered income with a value tied to the virtual currency’s fair market value on the day it was mined.
- Spending: Results in either short- or long-term capital gains or losses, depending on the holding period.
Crypto Tax Tips to Avoid IRS Problems
Here are four tips that can help you avoid taxation troubles if you’re buying and selling cryptocurrencies.
1. Always Self-Report
Unlike proceeds from selling stocks and bonds, you probably haven’t received a 1099 for your virtual currency earnings—although that may soon change. This means you are responsible for self-reporting all your gains and losses.
If you bought a car with Bitcoin, if you realized heavy losses with dogecoin, if you did a job for someone and got paid in Ethereum—these are all examples of reportable, taxable events. If you have not reported these transactions, consider that the IRS typically raises audit flags around two years after a tax return is filed. To avoid penalties, interest, and possible fraud charges, you should amend your previous tax returns so that your virtual currency transactions are accounted for.
2. Keep Track of Capital Gains (and Losses)
Many virtual currency transactions could result in capital gains taxes since the IRS views altcoins as property rather than income. This means you could end up paying significantly more taxes if you’ve realized a capital gain, but you may lower your tax bill if you’ve suffered a loss.
When reporting cryptocurrency for tax purposes, you should state when you purchased the currency, what you paid for it, when you sold it, and what you received for it. The basis (or purchase price) will be used to determine capital gains or capital losses. You may need to track the fair market value of the goods or services that you received or exchanged for virtual currency.
3. Keep Accurate and Timely Records
Without good recordkeeping, you may find yourself digging through old emails or scrounging around the junk drawer looking for past statements and receipts. Instead, keep an accurate ledger of all digital currency transactions and include information about dates, costs, trade partners, and the digital currency’s fair market value. You should also withhold an appropriate percentage from your proceeds to help cover potential tax payments and/or liabilities related to virtual currency. You’ll thank yourself when tax season rolls around.
4. Don’t Forget State Taxes
If you find yourself amending federal tax returns to avoid problems with the IRS, don’t forget about state returns. For states that tax income, typically the state tax return relies on the adjusted gross income from your federal tax return. Therefore, the tax implications of crypto sales also affect your state taxes, even if your state doesn’t explicitly tax crypto as a capital asset.
S.H. Block Is Happy to Discuss Your Cryptocurrency Tax Questions
Crypto is still a relatively new phenomenon, and the tax rules around cryptocurrencies continue to evolve. If you’ve missed any of these changes or have questions about how your virtual currency use may affect your taxes, a tax professional can make sure that you are reporting correctly on your taxes.
Please contact us at (410) 793-1231 or complete this brief form to schedule a free consultation where we can discuss your cryptocurrency investments and any other tax issues you might have. Statutes of limitations apply, so please reach out today!
The content provided here is for informational purposes only and should not be construed as legal advice on any subject.