Essentials to  Consider when Reporting Taxes on Cryptocurrency

Many people started investing in crypto for the first time in 2021, and crypto enjoyed explosive growth.

But much to their surprise, buying and selling Bitcoin, Ethereum, and other types of cryptocurrencies is taxable. Just like you have to pay taxes for your properties such as gold, stocks, etc., you have to pay cryptocurrency taxes as well. 

The reason?

The IRS, or International Revenue Service, treats cryptocurrency trades just as any other taxable event. However, there are still few public accountant tax professionals available to explain the taxation process. 

Consequently, there are many first-timers that don’t even know that they need to pay and report taxes on cryptocurrency, let alone know how to! So, if you’re one of them, you’re not alone. This article will explain everything you need to know about reporting taxes on cryptocurrency to IRS. But first, let's address a question novice investors often ask.

Do I Really Have to Report Cryptocurrency on Taxes?

Yes. Although there are ways to avoid paying taxes on Bitcoin, you have to report cryptocurrency on your taxes most of the time. However, there are some situations where you don’t need to. To understand what exactly you have to include on your tax report, first, you need to learn about taxable and non-taxable events. 

Keep a record of the taxable events, and know that you can’t pretend that you weren’t aware! In fact, the IRS has put a notice on the top of Form 1040 that asks: “At any time during 2022, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

Now, if you check this question as yes, the IRS checks if you also have filled out the IRS 8949 form. This form is used to report on sales and exchanges and losses and gains of capital assets. If IRS can not find this form, you are to be detected. 

However, as we mentioned above, not all activities need to be reported. Here’s a brief explanation of taxable and non-taxable events. 

What Are Crypto Taxable and Non-Taxable Events?

Since IRS identifies crypto as property, you need to report on capital gains and losses. But before getting to what you should report, let’s review what you should NOT.

Non-Taxable Cryptocurrency Events

Here are some examples of nontaxable events.

• Purchasing crypto with U.S. dollars and keeping it: Just buying cryptocurrency and keeping it or transferring it to your personal wallet, without any trades or gains, doesn’t require paying taxes. According to IRS, buying crypto is an investment, and if there are not any gains, then there’s no need to pay taxes for it. 
• Transferring crypto to your own wallet or account: Transferring crypto into another personal wallet or account is not taxable. IRS views this as transferring money from an old wallet to a newer one, and since you don’t gain any profit from it, there’s no need to pay taxes.
  Of course, this changes if you exchange the digital currency for another one before moving it.  
• Giving cryptocurrency as a gift: Gifting cryptocurrency up to a value of $16,000 per year based on the FMV, or Fair Market Value, is not taxable. Even if you transfer crypto for anything other than exchanging goods, it may count as a gift even if it wasn’t your intention. However, if the gift exceeds $16,000, you have to file a gift tax return or IRS Form 709.  
• Receiving cryptocurrency as a gift: If you receive crypto as a gift, you won’t need to pay taxes. However, if you sell, swap, or spend the gifted crypto, you should know that it’s subjected to CGT or Capital Gains Tax.  
• Donating cryptocurrency to charities: Donating crypto to a tax-exempt 501 (c)(3)charitable organization does not require paying taxes. 

Taxable Cryptocurrency Events

Now, it’s time to learn about taxable events.

• Converting cryptocurrency: Let’s say you have Bitcoin now, and you see a rise in Ethereum, so you decide to convert your crypto. To do this, you have to sell your Bitcoin first. When you sell your Bitcoin, IRS considers it a taxable transaction, which means that if you sell it for more than you paid, you have to pay taxes.  
• Selling crypto for cash: If you sell your crypto for cash and you earn more than what you paid for, you owe taxes. However, if you sell less than what you paid for, you may be able to deduct that loss from your taxes. 
• Using cryptocurrency to make a payment: Since IRS recognizes crypto as property, you have to pay for short or long-term capital gains tax if you use it to purchase something.
  Here’s an example: If you sell a $2 crypto that is worth $8 to buy a $3 coffee, you have to pay the tax for the $5 cashed-out profit you made. 

Taxable Events as Income

• Getting paid for a service by cryptocurrency: When you get payment in cryptocurrency, you must pay income tax based on the cryptocurrency's fair market value, and you also have to pay capital gains tax on the increase in value when you remove the funds.
• Getting paid in crypto: If your employee is paying you in crypto, you have to pay income taxes on its current value. 
• Mining crypto: Mining crypto is counted as self-employment income. So, if you mine cryptocurrency, you have to pay taxes on what you earned based on the Fair Market Value of the mined coins you received during that period.
  One thing to keep in mind: you can write off necessary company expenses like buying equipment, paying for electricity, getting repairs done, and renting space.
• Earning cryptocurrency as staking rewards: If you receive staking rewards, you owe taxes based on the Fair Market Value of the time you receive them. 
• Receiving airdrops from a crypto company: Sometimes start-up cryptocurrency companies offer free airdrops for marketing or to thank their investors. However, IRS does not treat them as gifts but as income. So, you have to report that amount in your taxes.
• Getting crypto from a hard fork: Taxes on cryptocurrency acquired during a hard fork vary depending on how you use the asset, when you can withdraw it from your exchange, and other factors.

Cryptocurrency Tax Rates for 2022

You may also need to know that your tax rate also depends on the length of time you kept the crypto before selling it. 

Cryptocurrency Short-Term Tax Rates

If you kept the crypto for 365 days or less, you’re subjected to short-term gains taxes. They’re equal to income taxes. Take a look at the table below to see the cryptocurrency short-term tax rates.

Cryptocurrency Long-Term Tax Rates

If you keep the crypto for longer than 365 days, it’s treated as a long-term tax. Look at the table below to see the long-term tax rates.

How to Report Cryptocurrency on Taxes?

Now that you know the basics of paying taxes on crypto earnings, it’s time to learn about reporting them.

There are 5 steps to reporting cryptocurrency on your taxes. Let’s review them together. 

1. Calculate Your Cryptocurrency Gains and Losses

Each time you dispose of your crypto, such as selling or exchanging it for another cryptocurrency, it will result in gains or losses. Some other disposal events may include:

• Selling cryptocurrency for fiats such as paper money or coins
• Exchanging crypto for another crypto
• Purchasing products or services with cryptocurrency

Now, you have to calculate the total gains and losses you receive from any of the above activities. To do this, you have to subtract the current value from the value at the time you received them. 

Here’s an example. Let’s say you bought Ethereum for $40,000 three months ago; the taxes for the mentioned taxable events would be like this:

• If you sell your Ethereum for $60,000, you have to report a $ 20,000 gain.
• If you sell your Ethereum at $58,000 to trade it for Bitcoin, you have to report an $18,000 gain.
• If you purchase a $65,000 motorcycle with your Ethererum, you have to report a $25,000 gain. 

After calculating the capital gains and losses, you have to file a Form 8949 report. 

2. Complete IRS Form 8949

Aside from including your capital gains and losses on your Form 8949, you should include the following information as well:

1. A description of the sold property
2. Your initial property purchase date
3. The date of sale or other disposition of the property
4. Earnings from the sale based on the fair market value
5. The pricing at which you purchased the property
6. Your gain or loss

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Note: Make sure to include your capital losses as well, since this is also a taxable event. It has a benefit for you too: you can use capital losses to offset up to $3000 of your personal income as well as capital gains.

3. Add the 8949 Totals to Schedule D

After you complete filling out Form 8949, Include the total of your net gain or loss on Schedule D.

You can record your total capital gains and losses from all sources on Schedule D. Schedule D also reports Schedule K-1s from enterprises, estates, and trusts in addition to your 8949 short- and long-term gains and your crypto-related activity.

4. Add any Cryptocurrency Income

As we mentioned before, if you earn crypto from mining, staking, or as a salary from work, they’re counted as income, and you have to include them all on your report. However, depending on the way you earned the crypto, you need to file a different report. 

Schedule 1: If you received cryptocurrency from forks, airdrops, crypto-related jobs, or other hobbies, this is typically included as “other income” on Schedule 1.

Schedule B: Schedule B is typically where you would declare any staking income or interest incentives from lending out your cryptocurrency.

Schedule C: Earning crypto as a part of a business, job payment, or running a mining project is treated as self-employment and should be reported on Schedule C. In such cases, you’re able to deduct the related cost, such as equipment, renting, and electricity. 

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5. Complete The Remainder of Your Tax Return

Now, you’re done! You can finish the rest of your forms and submit your cryptocurrency tax report to IRS. 

Although it sounded easy, this process becomes complicated if you have a lot of information to report. Our suggestion is to get help from a crypto tax professional.

Consult with a Cryptocurrency Tax Professional 

IRS only provides a little guidance regarding crypto tax. For this reason, you need to talk to a tax professional who is experienced in interpreting virtual currencies’ tax codes and is also knowledgeable about reporting the gains and losses of cryptocurrency. 

Lorenzo tax CPAs are among the best in the industry when it comes to cryptocurrency taxes. Our professionals have solid experience from working with many clients, so they know exactly what kind of approach is needed to manage your taxes. 

Even if you just want to start investing in cryptocurrency and don't know where to start, we’re here to help you with your crypto project in the shortest time possible. 

Here is a list of our services you can use to your advantage:

• Crypto tax consultation 
• Financial coaching
• Tax strategy
• Business consulting
• Estate planning
• Trust formation
• Business LLC 
• Tax preparation

If you think any of the above services can be helpful for your situation, book a call and see what’s waiting for you! 

Penalties for Cryptocurrency Tax Evasion

IRS has the sharpest eyes for crypto taxes. So, if you fail to pay your taxes for any reason, you have to pay large penalties. According to the report from 2021, a staggering 93% of all the assets that the IRS confiscated during the year were digital cryptocurrency. 

Let’s read about the different kinds of penalties in detail. 

Civil Penalties

A 75% fine will be assessed if agents find income or profits that have not been reported. Of course, the payment is made on top of the tax that should have already been paid, so the total amount of tax due almost doubles.

The IRS must establish purposeful fraud before it can impose this fine, which means the fraudster had to be aware of what they were doing and intend to deceive.

Criminal Penalties

Failing to be entirely honest and truthful on a tax return is a criminal violation in addition to the potentially expensive civil consequence. Once more, the prosecution must demonstrate that the person knew they were being dishonest and intended to mislead the authorities.

Genuine errors, such as faulty calculations or filling out the wrong form, are not criminal offenses.

Also, If you can prove that you are truly struggling, it is also not a crime to be unable to pay taxes. However, it goes without saying that in order to prepare a defense if you are under investigation, you should contact a knowledgeable attorney as soon as possible.

If found guilty of tax fraud, the penalties can be anything from a hefty fine to a maximum of five years in prison.

IRS is really strict about this matter since there are many uses of cryptocurrency for crimes. IRS made a report of the crimes committed by criminals using cryptocurrency:

• Identity theft
• Wire fraud and mail fraud
• Identity fraud
• Money laundering
• Sale or possession of counterfeit items
• Child exploitation
• Illegal sale of firearms
• Securities fraud
• Access device fraud
• Fraud in connection with computers
• Drug trafficking
• Transactions using the proceeds of illegal activity.

The days when people thought such crimes couldn't occur because there was no physical exchange of cash are gone.

Conclusion

Things may get complicated when reporting taxes on cryptocurrency. However, no matter how hard it is, it must be done if you don’t want to become a criminal. 

You should know that if you make lots of transactions, keeping track of them all and calculating all the long and short-term taxes can be pretty complex. That’s why getting help from a crypto tax professional might be your best option. 

You can book a call with Lorenzo Tax CPAs and ask any questions you have. 

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