The crypto market’s wild volatility has created many overnight millionaires and opened the door to entirely new business models. Like any other business or investment, individuals and businesses owe taxes on these gains or have an opportunity to claim the losses. A failure to properly account for these gains can result in steep penalties, interest or worse.
The good news is that it’s never been easier to properly handle Crypto Taxes and Accounting (though it’s still not as easy as it ought to be). Many crypto exchanges provide Form 1099 that contains the tax that you owe, while crypto tax software can help you aggregate transactions across multiple exchanges and even find ways for you to save on your taxes.
Let’s take a closer look at what happens if you don’t report crypto gains and how to remedy any mistakes you’ve made in the past.
What Are Capital Gains?
Most traders and investors are familiar with capital gains taxes for stocks. If you sell a stock, you owe a tax on the difference between the purchase and sale price (e.g. profit). While crypto is often associated with a currency, the IRS treats all crypto as property, which means that all transactions are subject to the capital gains tax—just like stocks.
There are a few situations where capital gains become tricky:
- Crypto to crypto trades. The conversion of one crypto to another involves the sale of the first crypto and you owe capital gains tax on the U.S. dollar value of the sale.
- Buying a coffee. The transfer of crypto to buy a coffee is considered a sale and you owe tax on the U.S. dollar value of the crypto sold.
- Receiving a fork. The receipt of any crypto due to a hard fork results in a new crypto position with zero cost basis and you will owe tax if you sell it.
- Mining crypto. Crypto mining creates new crypto with zero cost basis, although you may be able to deduct some mining-related expenses.
The capital gains tax rate depends on many different factors, including your income and holding time. In most cases, you can minimize the capital gains tax rate by holding a position for greater than a year and selling during a low-income year. Short-term trading by high net worth individuals tends to create the greatest tax liabilities.
Under Reporting Penalties
The IRS is well aware that most people don’t report their cryptocurrency transactions. In 2018, Fortune reported that just 0.04% of U.S. taxpayers reported crypto gains or losses to the IRS. The IRS has responded with warning letters, lawsuits demanding customer reports from large crypto exchanges and even a new questionnaire on Form 1040 starting in tax year 2019.
You should be especially careful to properly prepare your crypto tax returns if you receive Form 1099-K or Form 1099-B from a crypto exchange since a matching mechanism ensures the IRS has the same information. The IRS has also subpoenaed several crypto exchanges, including Coinbase and Bitstamp, to release information on taxpayers.
Map showing where IRS audits are more common. Source: Vox / Propublica
Tax evasion is a felony crime and the IRS can impose fines of up to $250,000, up to five years in federal prison or both on people who purposely try to evade filing and paying their federal income tax. In addition to these penalties, you will have to file your taxes and pay back the full amount of money that you owe, plus interest, to the IRS.
The IRS also has a long time to identify any mistakes. While the statute of limitation is typically five years for tax mistakes, fraudulent behavior has no statute of limitations. The IRS can take a look as far back as they want if you’re audited for any reason. Of course, the blockchain also keeps a permanent record of all crypto transactions!
How to Remedy Mistakes
There are many cases where individuals didn’t realize that they had to pay capital gains tax on crypto transactions or may have forgotten transactions in the past. If that’s the case, it’s always best to come clean as soon as possible to file an amended return. You may have to pay in some extra tax, but you usually don’t have to pay penalties and interest may be waived.
If you owe a lot of back taxes, you can also work with the IRS to come up with a payment plan or negotiate a one-time settlement. You can also request that the IRS temporarily delay collection until your financial situation improves. A tax lawyer can help you negotiate these terms and ensure that you get the best deal possible.
ZenLedger’s auto-generated tax form. Source: ZenLedger
Finally, it’s imperative to implement the right record keeping best practices to ensure that future taxes are properly calculated and paid. ZenLedger simplifies the process by aggregating transactions across wallets and exchanges and calculating your capital gains or losses. You can even find tax loss harvesting opportunities and pre-fill popular IRS forms.
The Bottom Line
The IRS has started to crack down on taxpayers that haven’t paid capital gains tax on crypto transactions over the past couple of years. While high net worth individuals have been subject to the greatest oversight, everyone should keep in mind that the IRS can discover anomalies over the years that could trigger the need to pay the full amount plus interest and penalties.
If you haven’t paid Crypto Taxes and Accounting, it’s a good idea to take immediate action to fix the problem by filing an amended return and discussing your payment options with your accountant or the IRS. You should also ensure that you’re properly reporting taxes on an ongoing basis, which is easy to do with ZenLedger or other crypto tax software solutions.