Welcome to the topic Cryptocurrency and IRS Taxes: What You Need to Know.
In recent years, cryptocurrency has become a buzzword as more and more individuals have invested in it. While cryptocurrencies such as Bitcoin, Ethereum, and Dogecoin provide numerous benefits, they also have unique tax issues.
In this blog, we’ll discuss everything you need about cryptocurrency and IRS taxes.
What exactly is cryptocurrency?
Before diving into cryptocurrency’s tax consequences, it’s critical to first grasp what it is. Cryptocurrency is a digital currency that is secured by encryption. Unlike traditional cash, it is not controlled by any government or financial entity.
Many advantages exist with cryptocurrency, including instantaneously transferring and receiving money, low transaction fees, and excellent security. It is also extremely transparent, as all transactions are recorded on the blockchain and are accessible to anybody.
Cryptocurrency has risen in popularity as an alternative investment in recent years. Many individuals see it as a means to diversify their portfolios while potentially earning a high return on investment.
There are numerous cryptocurrencies; the most well-known and commonly used is Bitcoin. Ethereum, Litecoin, and Dogecoin are also popular cryptocurrencies.
Each cryptocurrency has its features and applications, but they all work on the same fundamental concepts of decentralisation and cryptography.
How Does Cryptocurrency Get Taxed?
First, it is critical to recognise that the IRS regards cryptocurrencies as property rather than cash. Every time you use or sell cryptocurrency, a taxable event occurs. The IRS requires you to declare any taxable event involving cryptocurrencies, including purchasing, selling, and trading, on your tax returns.
Let’s take it further by reviewing some common taxable events.
- Cryptocurrency Mining
Mining cryptocurrency is the process of generating cryptocurrency by solving complicated mathematical equations. While it can be an amazing way to earn cryptocurrency, there are tax considerations. When you mine cryptocurrencies, you are effectively earning taxable income. It would help if you recorded any mining earnings on your tax filings.
- Investing in and Selling Cryptocurrency
When you acquire or sell cryptocurrency, you have a taxable event. If you sell cryptocurrency for more amount than you purchased it, you have a taxable capital gain. If you sell it for less amount than you paid for it, you will incur a capital loss, which may balance any capital gains.
- Paying for Goods and Services with Cryptocurrency
Using cryptocurrencies to pay for your products and services is also a taxable event. When you use cryptocurrencies to buy something, the cryptocurrency is sold, which implies you may have a capital gain or loss. Any gains or losses must be calculated and reported on your tax returns.
Reporting Cryptocurrency on Your Tax Returns
Reporting cryptocurrency on your tax returns might be a difficult task, but it is necessary to maintain compliance with IRS requirements and avoid penalties. You must utilise IRS Form 8949 and Schedule D to report cryptocurrencies on your tax returns. You must report each taxable event separately and compute any capital gains or losses on these forms.
To report cryptocurrency on your tax returns, you must collect information about each transaction, including the date, the cryptocurrency’s value, and any associated costs. Then you must decide whether the transaction resulted in a capital gain or loss and compute the amount of the gain or loss.
If you sell cryptocurrency for more than you bought it, you will have a taxable capital gain.
If you sold it for less than you paid, you have a capital loss, which can balance any capital gains. It’s critical to keep detailed records of your transactions to submit the correct amounts on your tax returns.
It’s important to note that if you got cryptocurrency as payment for products or services, you must disclose the cryptocurrency’s fair market value as income on your tax returns. Similarly, if you mine cryptocurrency, you must disclose the cryptocurrency’s fair market value as income.
You should see a tax specialist if you need help disclosing your cryptocurrency on your tax returns. They can advise you on the appropriate forms to utilise and ensure that you report your cryptocurrency accurately and follow IRS requirements.
The Consequences of Not Reporting Cryptocurrency on Your Tax Returns
Failure to report cryptocurrency on your tax returns can result in hefty penalties, fines, and criminal prosecution.
The IRS has stated that they are actively chasing individuals who fail to record their cryptocurrency transactions, and they have devised tools to assist them in tracking these individuals down.
One of the most serious repercussions of failing to report cryptocurrency on your tax returns is the possibility of penalties and fines. Failure to record cryptocurrency transactions can result in fines of up to 20% of the total taxes payable by the IRS.
Furthermore, they can levy a $5,000 or higher penalty for willfully failing to complete an FBAR (Foreign Bank Account Report) form required for persons who own cryptocurrency in foreign accounts.
Another consequence of failing to report cryptocurrency on your tax returns is the possibility of facing criminal penalties. If the IRS finds that you purposefully omitted to record your cryptocurrency transactions, you may face criminal charges for tax evasion, which can result in fines and even prison time.
Aside from these disadvantages, failing to report cryptocurrency on your tax returns can result in missed opportunities. By failing to record your cryptocurrency transactions correctly, you may be preceding valuable tax deductions and credits that could lower your tax obligation.
Conclusion
Cryptocurrency can be a great investment, but you must know the tax ramifications. Remember that using or selling cryptocurrency is a taxable event that should be reported on your tax filings. Keep detailed records of your transactions and declare your cryptocurrency using the appropriate paperwork.
You can avoid penalties and maintain IRS compliance by understanding the tax consequences of cryptocurrency.
Also Read: Tax Credits vs. Tax Deductions: What’s the Difference?