A Guide to Paying Taxes on Cryptocurrency

graphic of bitcoin profits and losses

With the new craze of investing in cryptocurrency sweeping the world, questions arise about if they are taxed. The answer is yes

In this article today, I will discuss the laws that are laid out for how cryptocurrency is being taxed. I will then go into the importance of reporting all crypto transactions and how the IRS is cracking down on enforcement and reporting. The government is taking the reporting of cryptocurrency very seriously, so if you are one of these people trying to strike it rich with crypto, read on.


How Does the IRS View Cryptocurrency?

Cryptocurrency is considered property or an asset to the IRS. This was declared in 2014. So, you must pay taxes on cryptocurrency gains when you dispose of the asset, much like stocks. This includes when you sell the crypto, trade for another form of cryptocurrency, or use it for payment of goods or services.

These different forms of crypto activity will not have one uniform tax rate.

If you received cryptocurrency as income, by mining it or as a promotion, it will be taxed at your ordinary-income tax rate.

If you dispose of or sell cryptocurrency, the profits will be taxed at the capital gains rate.

If you held the cryptocurrency for over a year, it will be taxed at a long-term capital gains rate.

If you held the crypto for under a year, it would be qualified as a short-term loss and would be taxed at your regular income tax rate. 

This is where it is important to keep good records of transactions and determining your cost basis. The cost basis is the original value of an asset for tax purposes, usually the purchase price. This value is used to determine the capital gain, which is the equal difference between the assets cost basis and the current market value.  

The good news and why it is so important to keep track you can write off losses to offset your capital gains or claim a capital loss deduction. This means when you sell your cryptocurrency if there is a profit that profit is taxable. If you sell it for a loss, then it still needs to be reported as a loss. 

The good news is you can deduct capital losses on bitcoin just like you can do with stocks. These losses can offset other capital gains and sales. If you are showing a loss after all gains and losses are tallied up to $3000 can be written off as a loss towards your other income. Unfortunately, if you are robbed of your bitcoin new tax rules do not allow you to take this as a deduction for personal loss.


The IRS Is Enforcing Crypto Reporting

Over the past few years, the IRS has sent letters to crypto taxpayers and they have sent IRS summonses to Coinbase, Kraken, Circle, and other firms that handle crypto transactions to turn over their records to the IRS for clients that had more than $20,000 in transactions in any year since 2020. 

During the 2020 tax year, they have added a question on the 1040 that asks, “At any time during 202 did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency.” The form gives you the option of yes or no. When you sign this form, it is under the penalty of perjury. It can be viewed that adding this statement is almost like setting the trap for very severe consequences in the future if the taxpayer is untruthful. 

By checking the box incorrectly, it can be said that there is per se willfulness if found to have held bitcoin. Willful failures carry much higher penalties and have an increased threat of criminal investigation.

The latest step was the announcement by the US Treasury Department that they plan to impose reporting requirements for crypto. Banks, financial institutions, exchanges, custodians, and crypto payment services are slated to have to report the IRS. 

It seems the rules they are setting up will be like the rules surrounding cash transactions even though the IRS had stated in 2014 that crypto was property, not currency. It is expected that businesses that receive more than $10,000 in cryptocurrency in a year will have to do a transaction report. This is the same as the rules set for cash transactions. When these cash transactions are not reported the laws make it a crime and the IRS Criminal Investigations Department would become involved. 

With the suspicion that people will try to structure around the reporting of crypto as they have been doing with cash income laws may be set in place with similar consequences for crypto making it quite dangerous not to report. With the possible consequences ranging from substantial penalties and fines to possible jail time, I cannot reiterate enough the importance of keeping good records.


How to Keep Good Cryptocurrency Records for Tax Purposes

With record keeping being of such importance, there is a need to know what you should be keeping track of throughout the year. It all starts from the initial acquisition of the crypto. Make sure to keep track of how much you paid for the crypto or mined it, this is the cost basis. When you are buying and selling stocks your broker would send you a 1099-b with all this information. With crypto at this point, this is not always done. The IRS is pushing for further enforcement, so this type of reporting begins to happen but for the time being, you must keep your own records to be safe. 

A lot of the investing platforms and exchanges are already starting to do this, so it may make sense to use those for your trading. If you are not using one of these platforms or exchanges, some software companies are emerging with programs that will scrub blockchains to detect transfers between your wallets whether on an exchange or not and will give you reports of all transactions related to those wallets. With these types of records, the tax filing process for cryptocurrency is still complex but these records will make it easier. Also keeping these detailed records and putting in the effort will limit your risk with the IRS.


How Do I File Cryptocurrency on My Taxes?

When filing your taxes with cryptocurrency income I would highly recommend hiring a true tax professional. As you see the laws are constantly changing and this income on tax returns is being watched by the IRS. Also, there are many ways that tax liability can be legally minimized by somebody who knows tax law. Enrolled Agents and CPAs are the ones who can act as tax preparers and are required to have the educational background to best serve you. 

If you decide to file this on your own it is especially important to know where and what forms are needed for the filing.  A great article in Forbes has listed and described these forms as follows:

Form 8949: This form logs every purchase or sale of crypto as an investment. This should include the total number of coins, the day and price you bought, the day and price you sold, and your gain or loss for each transaction.

Schedule D: This form summarizes your total capital gains and capital losses from all investments, including crypto.

Schedule C: If you received coins from mining, you need to disclose whether you received them as a business or as a hobby. If you are running a crypto mining business, you would report this income on Schedule C, and deduct your expenses. Your expenses might have to be extremely high, though, to offset any extra self-employment tax you would face if you counted your mining as a business instead of a hobby.

Schedule 1: If you report your crypto mining as a hobby, you will report this income on Line 8 of Schedule 1. You will not owe self-employment tax, but you become more limited on what you can deduct as an expense. 

It is not only important to make sure the correct forms are used but it is especially important to hire a tax professional to make sure that you are utilizing everything within tax law to limit your exposure to tax debt.  As discussed earlier in this article one thing that can be done is correctly offsetting any gains with losses to keep the taxable portion as low as possible. 

Another thing you would not want to miss would be the possibility to utilize expenses. If you are mining crypto, there are some expenses involved in this process. These expenses can be considered such as computers, servers, electricity, and internet. These expenses can be deducted from your income before being taxed saving you a lot on what you owe.

In conclusion, the once thought of as the “wild west” world of crypto is slowly becoming very monitored and regulated. The one thing that has not seemed to change is there is still a lot of money to be made in the acquisition and sale of cryptocurrency. I by no means am not trying to dissuade anybody from dabbling into this market. 

The major point of this article was to prepare and make people aware of the ever-growing seriousness of reporting this income made in this market. Keep on making that money, but make sure to shield yourself by hiring the proper tax professional and making sure things are done 100% correctly to enjoy the profits with no future worries about the IRS coming after you in the future.


Ozzie Gomez is a Senior Tax Settlement Agent and the owner of Innovative Tax Relief which holds business licenses in Tax Resolution, Tax Audit Representation and Tax Preparation.  With almost 10 years of experience in the tax resolution industry, he has personally helped more than 4,000 individuals and businesses resolve their tax issues.

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