Cryptocurrency is taking a more significant societal role, from individual income taxes, retirement/estate planning, transactions, and even salaries to professional athletes.
Those engaged in the crypto market will want to know how to comply with tax law currently in place and how to navigate the tax rule changes addressing crypto that are expected to come.
While crypto enthusiasts have good arguments supporting its viability, those conducting business using crypto may not be aware of the tax reporting and compliance obligations that accompany its use. In addition to the reliable, long-term store of value crypto shares with stock, crypto investors favor the mathematical algorithms that cap the cryptocurrency and prevent governments from weakening its value through inflation.
However, those invested in crypto, and those engaged in buying and selling it, will likely have to deal with new reporting/disclosure obligations as the market continues to develop. This article (the first in a series) focuses on the general federal income tax rules for virtual currency and examines potential pitfalls for taxpayers in reporting and compliance in this developing market.
For the moment, the IRS maintains that cryptocurrency is a capital asset subject to tax, similar to traditional stock. You realize a taxable gain if you sell your crypto at a profit, and you can claim a capital loss (potentially offsetting other income taxes) if the crypto market took a downward turn before you sold. The long-term capital gains rates, which may be favorable depending on your income, only apply to crypto if you held your crypto for one year or more before you sold, disposed of or exchanged it.
The recordkeeping requirements of IRS Form 8949 (to report other dispositions of capital assets) can be onerous, especially for those who conduct business using crypto throughout a given year. Furthermore, the IRS can track these transactions using multiple channels. The IRS is making efforts to “close the virtual currency information gap” by developing third-party reporting systems (returns of brokers) to identify crypto transactions that cannot be easily identified on typical reporting forms, such as a Form W-2 (for employee wages), a Form 1099-MISC (for nonemployee payments made in the course of trade or business), and, more relevantly, a Form 1099-K (for third-party payment network transactions made via platforms such as PayPal, Venmo or Zelle or, in the crypto context, a crypto exchange platform such as Coinbase, Binance.US, or Crypto.com).
Though the IRS has a reduced interest in looking into unreported virtual currency transactions of relatively small value, taxpayers who discovered they failed to report and do not act are playing a dangerous game that could result in interest and penalties being imposed or even criminal charges being brought. Furthermore, whistleblowers who report missing activity to the IRS are eligible for monetary awards in the form of a percentage of any penalties collected. Crypto investors and traders should be wary: transactions added to the blockchain are indelible. The federal government has no time limit for bringing civil tax fraud claims against a taxpayer.
Investors and their businesses who fail to report any income relating to virtual currency have a three-year lookback period to amend prior returns. They should seek professional tax and legal representation.
Nevertheless, if you are a crypto investor/trader concerned with compliance, consider obtaining a complete accounting of all your crypto activities on every platform you use. Doing so allows you to do some of your own tax planning (e.g., determine the capital gains treatment you qualify for (long-term/short-term)), but, more importantly, this ensures at least some basic tax compliance is being done.
Michael Pollock is an associate attorney with Wright Lindsey Jennings who advises and represents companies and individuals in tax and business matters. The opinions expressed are those of the author.