Cryptocurrencies like Bitcoin and Ether have gained a lot of traction over the last several years. However, crypto regulations are notoriously vague, particularly in regard to cryptocurrency taxes. Some crypto traders even found themselves in trouble with the IRS for unintentionally violating tax laws. Last year, the IRS began a highly-public crackdown on Crypto tax evasion, so following the rules is more important than ever before. Here’s what you need to know to stay on the government’s good side.
The IRS Crypto Crackdown
Cryptocurrencies are volatile, so there are lots of opportunities for astute investors. However, some traders neglected to report their earnings to the IRS. For some, The rules were very unclear in the early days, so many traders didn’t even know they owed cryptocurrency taxes. However, the IRS started to pay closer attention when Bitcoin went mainstream in 2017. In July of 2019, the IRS launched its Virtual Currency Compliance campaign in an effort to address noncompliance among virtual currency holders.
IRS Crypto Warning Letters
As part of the Virtual Currency Compliance campaign, the IRS sent thousands of warning letters to suspicious traders last year. Some of the letters only provided educational information to warn virtual currency holders that they potentially underreported their earnings. The less-threatening letters encouraged individuals to file an amended tax return. However, Letter 6173 asked for a response within 30 days.
Then there was CP 2000. This letter directly warned that the individual’s income didn’t match IRS records. These letters listed the discrepancy and applicable interest. If you received Letter CP2000, don’t ignore it. You have to take action.
You can either verify the amount owed, remit your payment, or file a response that proposes your version of the discrepancy. If you dispute the total, you also need to supply supporting documentation to prove your numbers are correct.
How to Avoid IRS Penalties
When it comes to cryptocurrency taxes, keep things as honest and transparent as possible. The IRS views cryptocurrency as property, and so any capital gains acquired from the sale or transfer of said property must be reported as income, the same as the sale or transfer of any other asset. You are also allowed to report losses if sales or transfers resulted in a capital loss. Then, you can write off up to $3,000.
To avoid IRS penalties, always report your earnings accurately. You should accurately calculate losses or gains to ensure your figures are correct. To determine your capital loss/gain, take the purchase price of your position, including fees, and subtract it from the selling price. If the number is negative, you took a loss. If it’s positive, you profited. Accurate recordkeeping is absolutely essential, even for crypto traders.
Taxable Cryptocurrency Transactions
Remember, the IRS is looking for taxable events, which only occur upon the sale or trade of the asset. Buying or holding crypto doesn’t incur cryptocurrency taxes. You must sell the asset to create a taxable transaction. You could owe cryptocurrency taxes if you made one of these transactions:
- The trading of cryptocurrency to fiat currency
- Trading cryptocurrency to virtual currency
- Units of a cryptocurrency received as the result of a fork
- Receiving cryptocurrency in the form of compensation for goods or services
In addition, receiving cryptocurrency in the form of a gift does not initiate a taxable event unless the gift is over the gift exemption amount.
How to Safely Report Cryptocurrency Holdings
Reporting your income accurately with the IRS is the best way to stay out of the hot seat. To report your income on your taxes you will need to fill out form 8949. Form 8949 is used to report the sale or exchange of assets to the IRS. You will also need to fill out Schedule D to report capital gains or losses. Schedule D accompanies your 1040.
You could receive a 1099-K from your exchange. Cryptocurrency exchanges like Coinbase are only required to issue Form 1099-K if you earn over $20,000 with over 200 transactions. If you get a 1099-K, the IRS gets one too. Make sure you report the totals accurately, or the IRS will immediately know you’re fibbing.
Paying Your Cryptocurrency Tax Bill
If you find you owe taxes as a result of your cryptocurrency activities, you can easily pay your tax bill online. Simply create an account on the IRS website. From there you can pay by checking account, debit card, or credit card. If you are unable to pay your tax bill, you can set up an installment agreement online as well. Just be sure to do this before the tax deadline to avoid any penalties or interest payments.
Cryptocurrency Compliance Help
Did you know that cryptocurrency that is sold or traded within a year of ownership is subject to a higher tax rate? This is the type of advice that tax professionals can provide. A tax advisor can help you with crypto tax planning and much more. Contact the tax experts at Shared Economy Tax now to learn more. For more cryptocurrency tax tips, subscribe to our newsletter below.