Depending on the month, day, hour, or minute you check the news, you might think investing in cryptocurrency or being paid in cryptocurrency is the greatest idea since sliced bread or the worst possible use of your money, ever. Whether you agree with Warren Buffett that cryptocurrency has “no value” or think Bitcoin’s value will rise to $300,000 in 2022, there’s one thing about cryptocurrency that isn’t up for debate: getting it right on tax returns has never been more critical.
The IRS is aggressively working to identify and root out United States taxpayers who are required to report cryptocurrency transactions, but either incorrectly report or omit cryptocurrency entirely from their tax returns. Understanding the tax implications of buying, selling, exchanging, or earning cryptocurrency has never been more important. We’ve identified ten common mistakes made when reporting (or not reporting) cryptocurrency transactions to the Internal Revenue Service, and will detail how to avoid each mistake in its own article. Finally, we will end the Top 10 Crypto Tax Mistakes To Avoid series with suggestions for the IRS on how to better reach out to taxpayers who are making Crypto Tax Mistakes, and how to bring those taxpayers back into compliance. As a tax litigator, it is my job to Monday-Morning Quarterback how taxpayers and their tax professionals did the first time around. This series aims to help folks get it right from the beginning, or identify possible mistakes that may need to be addressed.
Number 10: Improperly Reporting Cryptocurrency Received From Air-drops, Forks, and Splits
“Air-drops, forks, and splits” may be foreign terms to rookie cryptocurrency investors, but it’s important for anyone even dabbling in this area to become quickly familiar with them as they have tax implications. Revenue Ruling 2019-24 specifically addresses these thorny issues, and we will help you work through the complexities of these events and how they impact your tax reporting requirements.
Number 9: Failing to Report Crypto-to-Crypto Transactions
It is common for crypto investors to exchange one cryptocurrency for another in a coin-to-coin transaction. It’s important to understand these are taxable events and how they should be reported.
Number 8: Using the Wrong Form to Report Cryptocurrency Transactions
Are you being paid in cryptocurrency? Did you exchange a car for crypto or vise versa? Are you simply investing in crypto? Are you mining crypto? Each one of these potential transactions may require a different IRS form to accurately report the transaction and calculate the tax consequences.
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Number 7: Improperly Reporting Cryptocurrency Received as Earned Income
Cryptocurrency received in exchange for performing services is not taxed the same as the sale of cryptocurrency held for investment. We will explore and explain proper tax treatment of cryptocurrency as income.
Number 6: Failing to Report Cryptocurrency Exchanged for Goods and Services
Thinking of paying for your new outdoor furniture from overstock.com in Bitcoin? As more and more retailers accept cryptocurrency, taxpayers need to understand the tax implications and reporting requirements associated with paying in crypto.
Number 5: Failure to Prepare and Maintain Adequate (or any!) Records Reflecting Crypto Transactions
As with any taxable sale or exchange of property, taxpayers must be able to establish basis in an asset, including cryptocurrency, in order to calculate the gain or loss and resulting tax due. Taxpayers who don’t keep good records may find themselves paying tax on the sale of crypto as if they had no basis at all in the asset. Taxpayers should resist the urge to be lulled into laziness and assume all records will be available electronically come tax time.
Number 4: Failure to Properly Calculate Cryptocurrency Gains and Losses
Did you lose money on cryptocurrency? Losses can and should be reported to the IRS just like gains, and losses may completely offset any tax consequences of gains. But if they do, taxpayers still need to report the transactions. Cryptocurrency investors are not uniquely required to only report and pay taxes on gains, and should include losses and gains when calculating tax due.
Number 3: Using Like-kind Exchanges to Report Crypto
In all fairness, this isn’t really something that I have seen any of my clients do. But because crypto held as investment is required to be reported as property, it makes sense that crypto exchanges for property, like a Tesla or exchanging Bitcoin for Ethereum should qualify for a like-kind exchange under section 1031 of the Internal Revenue Code. Unfortunately, it doesn’t.
Number 2: Failure to Take Proper Steps to Pass on Your Cryptocurrency in the Event of Your Death or Disability
Do your loved ones know how to access your cryptocurrency accounts? If you die or become disabled, the value of your cryptocurrency may well be included in your taxable estate, even if your loved ones can’t actually access or unlock the value of that asset. We will explore best practices for how to ensure your loved ones are not left cleaning up your crypto mess without any access to the value of the asset.
Number 1: Failure to Report Cryptocurrency at All
By far the worst error – whether intentional or unintentional – taxpayers make when it comes to taxes and cryptocurrency is failure to report crypto transactions at all. Carolyn Schenk, the National Fraud Counsel & Assistance Division Counsel for IRS Office of Chief Counsel put it this way when addressing crypto investors who are not reporting income, “We see you.”
Putting it all Together
Since I’m not the Commissioner of the Internal Revenue Service, I don’t get to decide how the IRS is going to handle increasing and improving outreach to taxpayers who should be reporting cryptocurrency transactions on their tax returns, and I don’t get to decide how the IRS is going to bring those taxpayers into compliance. But as a tax litigator, I have a lot of ideas on how I think the IRS should be accomplishing these goals. We will finish our series with a close look at how the IRS has been handling outreach and enforcement so far, and what we’d like to see in the future.