Knowledge is power, but without wisdom as to how to apply your knowledge, you could end up as a really smart fool. Here are eight things you need to know about crypto taxes. Equally important is the practical wisdom needed to help you apply each bit of tax knowledge effectively.
Eight Key Crypto Tax Facts
1. Big Bro and His Little Helpers Are Watching You
Yes, you must account for all of your cryptocurrency gains and losses. Blockchain technology does not make your crypto buys and sells invisible to the tax authorities. In fact, it can make it that much easier for them to monitor everything about you. Particularly your financial transactions. Big Brother is watching, and he uses your friendly banker, money transfer service, and crypto exchange as unpaid surveillance agents. They fear Big Bro as much as you do, and boy, do they have a lot to lose if they fail to comply with his demands for information about you and your transactions.
2. Bitcoin Is Taxable Property
Bitcoin is classified as property by the IRS. Anything the IRS is interested enough in to classify as property is something they are equally interested in taxing. You need to take action right now to get in and stay in compliance with all of the IRS rules governing cryptocurrency capital gains and losses. Love letters from Uncle Sam generally do not include flowers or chocolates, but they do come gift-wrapped with the implied threat of bank account seizures, fines, penalties, and in some Mafia-related cases, a RICO indictment and other criminal charges.
3. No Need for You to Report Bitcoin Wash Sales, Yet
Bitcoin is not subject to the infamous wash sale rules applicable to stock traders, at least not yet. However, since the IRS stands to make hundreds of millions of dollars a year by instituting this tax rule, it may yet be applied to Bitcoin, and to all other cryptocurrencies, possibly within a few years. If you’re not familiar with the wash sale rules, become knowledgeable about them. To save space here, the easiest way to avoid being nickel-and-dimed to death (tax-wise) by it is to trade only one cryptocurrency. Trade it infrequently, and never enter a new trade within 31 days of closing out the previous trade. Long-term trend followers and dollar-cost-average investors generally need not worry about wash sales. Swing traders and day traders are the main targets of the wash sale rules.
4. Plan Ahead, Avoid Surprises, Fill out Your Form 1040-ES
If you anticipate big capital gains or losses in your cryptocurrency trading, you should complete IRS Form 1040-ES. You keep this form for your records. You do not need to mail it to the IRS. Instead, you use the calculations in the form to determine if you need to make quarterly estimated tax payments. If you’re self-employed, you’re already doing this, so simply add in your anticipated crypto gains and losses. Pay your quarterly estimated taxes on time and everything’s hunky dory.
5. 1099-B, 1099-K, and Self-Responsibility
Some crypto exchanges (Gemini, Kraken, Coinbase, etc.) will issue you a Form 1099-K at tax time. Coinbase is also considering sending out 1099-B forms in lieu of the 1099-K. These forms contain important trade transaction dollar amounts that you need to prepare your Federal (state) income taxes. But what if your crypto exchange fails to provide you with either form? You’re still responsible for reporting every single Bitcoin, Ethereum, Litecoin, etc. transaction for the entire tax year.
You, not your broker or crypto exchange, are the party responsible for the veracity of the information in your 1099-B and 1099-K forms. Therefore, you must ensure that the info they provide you is accurate.
6. Digital Deliverance via Specialized Tax Preparation Services
You might be overwhelmed when you receive your first Form 1099-B or Form 1099-K. Especially if you’ve made hundreds of crypto trades during the tax year. That’s because the figures listed for both cost basis and net proceeds are the total dollar amounts for all of your transactions.
But don’t panic, the IRS relies on your crypto exchange or broker to provide these gross transaction totals. All you need to do is import them into your Form 8949 and Schedule D at tax time. If you don’t feel comfortable preparing your own tax return, many accounting firms offer specialized crypto tax prep. It’s not cheap, but you won’t have to sweat it, worrying if you’ve made a mistake on your tax return.
If you’re more adventurous, you can buy or lease crypto-specific tax prep software and let it handle the number crunching and form completion work. It may be worth the cost to produce an error-free return and gain added confidence when filing your taxes. You can also avail yourself of this same convenience when preparing your annual crypto capital gains tax returns.
7. Received a Notice from the IRS? Don’t Panic
It happens. You might forget to include a tax form with your Federal return. Perhaps you neglected to include that little $1,000 cash tip you got for completing a work project ahead of schedule. Maybe you accidentally lowballed the amount due on your quarterly estimated tax payment. Then, the IRS sent you a letter complete with proposals for fines and penalties.
Don’t freak out. Those are tentative fines and penalties. If you respond to them immediately and correct your mistakes quickly, they will usually back off. Honest mistakes are not a big deal with the IRS, but only if you move fast to correct your errors. You’ll probably need to file an amended tax return (Form 1040-X) and absolutely send in any extra tax due. If you forgot to send in a certain tax form, mail it in pronto. And no mistakes this time, please.
You may want to contact an enrolled agent (EA) to represent yourself before the IRS. They can prepare a 1040-X (amended federal tax return), complete with any missing forms. If necessary, they could also petition the IRS, requesting that the penalty and tax proposal be put on hold.
Two lessons here for you: First, always triple-check your tax return for accuracy and completeness before sending it to the IRS. Second, if you do get a scary IRS letter because of a screw-up, don’t lose your cookies. There are many tax firms that specialize in dealing with the IRS. For a fee, they can help clear matters up more quickly than you can yourself. Don’t go it alone when you get an IRS notice regarding big fines or additional taxes!
8. Buy a Coffee, Get a Taxable Event at No Extra Charge
Say you funded your crypto account with $10,000 of Bitcoin at $5,000 per unit for a total of two units. You buy your morning coffee for $4.99 USD. Bitcoin is trading at $7,500 at the time of your purchase. You used .00066533333 Bitcoin units to pay for your coffee (.00066533333 units * $7,500 = $4.99).
Your Bitcoin units have increased in value by 50 percent since you originally purchased them (BTCUSD rose from $5,000 to $7,500). Therefore, the original value of the units has risen from $3.33 to $4.99. Congratulations. You’ve generated a capital gain of $1.66 as you paid for your coffee. You must account for this capital gain (and properly classify it as a short-term or long-term capital gain, too) at tax time.
You might have hundreds of similar small-dollar-equivalent crypto transactions throughout the year. So make sure you account for each one because the IRS certainly is. If you screw up and don’t report all of your taxable transactions, they’ll certainly be in contact with you. Usually when you least need an unpleasant surprise.
Would you rather one tax lump – or two?
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