Benjamin Franklin once said, “in this world, nothing is certain except death and taxes.” While it’s fair to say that Mr. Franklin didn’t have cryptocurrency in mind when he made this statement, it applies in full force to crypto investors. If you traded cryptocurrency during the year, come tax time, you’ll need to pull up your transaction history to determine what, if any, taxes you owe on your investments. However, before you get started preparing to pay your crypto taxes, there are a few things you should know.
1. Cryptocurrency Transactions Are Generally Taxable
According to the Internal Revenue Service, cryptocurrency or “virtual currency, as the IRS calls it, is considered “property” under the tax code. Thus, any gains you make trading crypto are subject to federal income tax. On the flip side, if you lost money on your cryptocurrency investment, you could write off your crypto losses as investment losses.
The IRS is privy to the fact that many crypto “hodlers” may not be aware of their tax-filing requirements (or may choose to ignore them). Thus, the IRS recently included a question on IRS Form 1040 (the most commonly used form to report income) asking, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
This raises an important point: you may be required to pay taxes if you used crypto to purchase goods. The bottom line is that, unless you bought and held crypto through the year, the transaction is considered a taxable event. In other words, you only need to check “yes” to the question on Form 1040 if you sold, exchanged or received crypto in exchange for goods or services. Thus, if you bought (and didn’t sell) or received crypto as a bona fide gift, you can answer “no” to the question.
2. Cryptocurrency Transactions Are Taxes at the Various Rates
Because cryptocurrency is considered property, much like stocks, the tax rate you must pay on your cryptocurrency gains depends on how long you hold it. Of course, other factors will play into the tax rate; however, crypto transactions are either taxed as short-term or long-term gains. A short-term gain is defined as a buy and a sell occurring within 365 days. Long-term gains are logged when you sell cryptocurrency after holding it for more than a year.
The short-term gain tax rate for cryptocurrency is the same as for other short-term gains. For example, in 2021, the short-term tax rate ranges from 10% to 37%, depending on your income. The rate for long-term crypto gains in 2021 is significantly lower, ranging from 0% to 20%, again, depending on your income.
These tax rates are scheduled to remain the same for 2022; however, the income threshold between tax rates changes slightly based on inflation.
3. You Must Use Form 8949 to Report Crypto Gains or Losses
Checking the box on Form 1040 is not the end of your obligations if you engaged in any type of cryptocurrency trading. You must also provide details about each transaction. To do this, you must use IRS Form 8949, entitled “Sales and Other Dispositions of Capital Assets.”
When filling out Form 8949, you must provide the following for each transaction:
- The name of the cryptocurrency;
- The date you acquired it;
- The date you sold, traded, or otherwise disposed of it;
- The sales price (or the proceeds);
- Your cost basis (usually this is the amount you paid for it); and
- Your total gain or loss.
If you bought and sold many times over the course of the year, this can quickly become a challenging task. Not only that, but there are multiple ways of reporting your transactions. For example, if you bought $1,000 worth of crypto in May, June and September, and sold $750 in August, November and December, you must determine which “assets” you sold. In other words, when you sold in August, were you selling the crypto you purchased in May or June. While this may seem like a distinction without a difference, it can impact your overall gain or loss, as well as whether long-term or short-term tax rates apply.
4. Don’t Forget to Report Cryptocurrency Losses
The IRS is obviously most concerned about you reporting crypto gains; however, from your perspective, it’s also important to accurately report crypto losses. When you report a crypto trading loss on Form 8949, you can “write off” those losses against other gains you made that same year. If you lost more than you made in any given year, you can even carry over those losses to offset future gains.
5. Failing to Claim Cryptocurrency Gains Can Come at a Tremendous Cost
Given the IRS’s decision to include a question about cryptocurrency at the top of Form 1040, it’s clear that the IRS is taking the taxation of cryptocurrency gains seriously. In fact, the IRS has recently ramped up enforcement efforts against those who do not report their capital gains related to the sale of cryptocurrency. Depending on the situation, failing to claim gains related to the sale, redemption, or exchange of cryptocurrency can result in significant tax penalties and even criminal proceedings being brought against you.
Are You Facing IRS Enforcement Action or Criminal Charges Based on Your Alleges Failure to Report Cryptocurrency Transactions?
If you recently received word that you are under investigation by the IRS for not reporting crypto gains, it is imperative that you take the situation seriously. Now more than ever, the IRS is on the lookout for tax evasion related to cryptocurrency, and it’s likely they will try to make an example out of those they identify as having intentionally withheld crypto income. At Oberheiden, P.C., we represent crypto investors in IRS and criminal proceedings, helping them clear up the situation and minimize the amount they need to pay in back taxes. We can also reduce the chances of criminal charges being brought against you. To learn more, and to schedule a free consultation with a crypto tax lawyer at Oberheiden, P.C., fill out our online contact form today.