Bitcoin and other forms of cryptocurrency have experienced record-breaking growth in recent years, leaving many investors grappling with uncertainty and surprise during tax season. Introduced in 2009, Bitcoin was the first cryptocurrency and remains the most widely used. Other cryptocurrencies have grown tremendously since then, including Ethereum, Chainlink, Doge, and Uniswap. Experts predict the use of Bitcoin and other cryptocurrencies will continue to increase, making it imperative that tax professionals are prepared to understand and educate their clients on the tax implications of these types of transactions.
How is the IRS Handling Cryptocurrency Transactions?
The first page of IRS Form 1040 asks if at any time during the year you received, sold, or exchanged, or otherwise disposed of any financial interest in any virtual currency. If you have any taxable transactions, you should check “Yes.” If you have a nontaxable transaction – just buying Bitcoin or another cryptocurrency – you should check “No.”
Reporting Taxable Transactions
According to IRS Notice 2014-21, the IRS considers cryptocurrency as property, and capital gains and losses need to be reported on Schedule D and Form 8949 if necessary. As a result, the most common crypto transactions that you do need to report on your tax return include:
- Selling your Bitcoin or other crypto for cash
- Trading one cryptocurrency for another cryptocurrency
- Buying goods and services with your cryptocurrency
In addition to reporting your capital gains and losses, you may need to report certain transactions as ordinary income, including:
- Receiving airdropped tokens
- Receiving tokens as a result of a hard fork
- Staking cryptocurrency
- Yield farming and Liquidity Mining
- Referral bonuses
DeFi, DEX’s, Staking, Yield Farming, and NFT’s
The emergence of DeFi came primarily from the rise of decentralized exchanges such as Uniswap and Sushiswap, and smart-contract-based platforms such as Compound and AAVE. Your trades that occur on these decentralized platforms are equably taxable, and the IRS expects you to utilize your transaction history to fulfill your tax obligations.
If you’re staking in a Proof-of-Stake consensus, you’re locking your crypto assets into a staking pool to earn more tokens as a reward for helping validate transactions on the blockchain. Staking helps secure the network and earn passive income. Staking rewards are taxed as ordinary income rates; however, if you later sell those rewards you will need to recognize a capital gain or loss.
Yield farming allows users to lend their cryptocurrency assets to DeFi platforms and receive a return in the form of interest, fees, or new tokens for providing liquidity. Earnings are calculated as annual percentage yiels (APY) and are taxed like your staking rewards.
Non-fungible token (NFT) is a digital certificate of ownership rights built on the blockchain. If you are an artist who earned money from selling an NFT, your profits are taxed at ordinary income rates. If you invest in NFTs, any profits earned through sales or trades will be subject to the capital gains tax.
IRS & Crypto Exchanges
The IRS is beginning to crack down on individuals who invest in Bitcoin and other cryptocurrencies but fail to report it on their tax returns. Cryptocurrency exchanges – like Coinbase, Crypto.com, Kraken, Gemini, and Robinhood – are actively providing your cryptocurrency holdings to the IRS to ensure that individual reporting requirements are being met. Most exchanges will provide their users (as well as the IRS) with Form 1099-K if they exceed $20,000.00 in trade volume and have more than 200 transactions. Exchanges will also issue their users (and the IRS) Form 1099-Misc if they make more than $600 from crypto rewards or staking from the previous financial year.
If you’ve received any tax forms from Coinbase or other crypto exchange, so has the IRS – and they’ll be expecting you to file taxes on your cryptocurrency transactions. Even if you have not received these forms you are still obligated to report your holdings to the IRS. If you fail to do so the penalties can be massive, up to and including prison for tax fraud.
IRS Subpoenas and Warning Letters
IRS is actively seeking investor information from cryptocurrency exchanges by issuing subpoenas or John Doe Summonses (JDS). A JDS allows the IRS to obtain the names, requested information, and documents concerning all taxpayers in a certain group. The IRS has already served subpoenas on Kraken, Coinbase, and Circle.
The IRS has started sending warning letters to investors that specifically address the taxpayer’s failure to accurately report their taxable cryptocurrency transactions. These letters may come in three variants: 6173, 6174, or 6174-A. If you received one of these letters, you are at a high risk of audit.
How We Can Help
Gordon Delić & Associates can help you avoid costly tax mistakes that can come from receiving, selling, or transacting with cryptocurrency by accurately reporting your taxable transactions. We can also help if you’re facing an audit from the IRS for failing to report these transactions. If you didn’t keep track of your transaction history, we can find your transactions on the blockchain and include them on your tax return.
We have the experience to help guide you to make educated and strategic decisions that promote your financial security and tax compliance. If you’re already facing the IRS and a complicated tax issue related to cryptocurrency, Gordon Delić & Associates can help you understand and navigate your options. We’ll begin with an honest assessment of your situation and create a plan for the best possible outcome. Achieving tax compliance can be difficult, let us help you get there. Contact us if you’d like to learn more or schedule a risk-free and confidential consultation.