By Saurav Bhandari, CPA
The IRS is keen to institute greater tax compliance among cryptocurrencies, so CPAs could be in greater demand when it comes to the filing of tax returns for holders of virtual currency. This means you must keep abreast of the required information and documentation so you can help clients accurately report cryptocurrency-related tax obligations.
In the absence of a de minimis tax exemption, even the smallest transaction – be it a micropayment for coffee or rounding up spare change to invest in virtual currencies – could have tax implications. Whether earned via mining, received as a gift, or purchased off an exchange, the IRS wants cryptocurrency holders to keep track of the cost basis.
In 2019, the IRS sent warning letters to about 10,000 U.S. cryptocurrency owners, urging traders and owners to include virtual currency transactions as part of their tax filings. The IRS has upped the ante by adding a direct question about cryptoasset ownership and trading as a checkbox on the first page of the Form 1040 Schedule 1. Cryptocurrency tax evaders could face legal prosecution and fines of up to $250,000.
The IRS is also requesting customer data from major exchange platforms such as Coinbase and Bitstamp. The requests are part of the increasing cost of compliance for businesses operating in the virtual currency space as regulators move toward stricter monitoring standards.
For virtual currency owners who make an effort to accurately report their transactions, the IRS has recently sent entitled refunds as a way of incentivizing further honest cryptocurrency tax reporting.
Given the novel nature of cryptocurrencies and the need for more robust and accurate reporting, CPAs play a vital role in helping people comply with the IRS’s demands. Of course, there is always the possibility of an IRS audit.
Cost Basis: Follow the Crypto
Toward the end of last year, the IRS updated its cryptocurrency taxation guidelines for individuals and corporations. The amended rules extended the cryptocurrency tax burden to cover aspects of the industry such as hard forks and airdrops. One of the first jobs regarding tax payments and cryptoassets is determining the nature of the ownership of the digital currency in question. While the IRS generally classifies cryptocurrencies as property for tax purposes, some tax treatments will fall under capital gains, as is the case with stocks and other investment instruments.
When earned as wages, digital currencies fall under federal income tax, which is reported on Form W-2. Those who receive salary payments in cryptocurrency should ensure that they obtain a Form W-2 from their employers.
A key element for the taxation of cryptocurrency is cost basis, the initial value of any cryptocurrency holdings. Keeping detailed records will help determine capital gains or losses on digital coins. It is advisable to obtain all transaction data from the various exchange platforms. Exchange customers with digital coin sales exceeding $20,000 from at least 200 different transactions usually receive a Form 1099-K.
All filings relating to capital gains or losses are reported on Form 8949. Those who make regular micropayments with cryptocurrencies need to ensure diligent tracking of all such transactions during the previous year.
The potential burden brought on by having to account for microtransactions is one of the arguments in favor of a de minimis tax exemption for cryptocurrencies. The U.S. Congress currently has bills detailing such proposals, with minimum limits of $200 and $600 respectively. Critics say such a move would incentivize tax evaders to adopt creative accounting practices that would see transactions made to fit the exemption criteria.
Audits and Cryptocurrency
The possibility of an IRS audit is another reason why cryptocurrency owners should turn to a CPA when filing taxes.
When assisting clients under audit, the first consideration is to get a sense of the likely issue. Thus, like with the tax preparation process, it is essential to obtain all the relevant trading history.
These documents include completed Form 8949, income statements from airdrops, forked coins, and rewards from staking altcoin tokens, among others. Ideally this would take the form of a complete, auditable comma-separated values (CSV) file that has the first-in, first-out/last-in, first-out matched buys and sells with timestamps.
After gathering all of the above backup you can help respond to queries from the IRS. Time is of the essence when dealing with an IRS audit, as there is usually a 30-day expiration period before costly increases on the interest payable are levied.
Saurav Bhandari is a CPA at BearTax. He's an expert in cryptocurrency taxation, and can be reached at email@example.com.
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