The number of Americans who own cryptocurrency doubled from 7.95% in 2018 to 14.4% in 2019, according to Finder, which translates to more than 36 million individuals. While a growing number of Americans are interested in trading or owning cryptocurrencies, they may not be prepared for the tax issues that come along with that ownership.
Let’s take a look at how cryptocurrency accounting software can help you ensure an accurate tax filing, as well as how to decide on the best solution for your needs.
Crypto Tax Accounting 101
Cryptocurrencies have become a hot button issue for the IRS. In addition to sending out “educational” letters in 2019 and 2020, the agency added a cryptocurrency question to the top of Form 1040 that forces cryptocurrency holders to disclose if they received, sold, sent, exchanged or otherwise acquired any financial interest in a virtual currency.
Despite their name, cryptocurrencies are actually considered property by the IRS and follow many of the same rules as stocks and bonds. Anyone that sells or exchanges a cryptocurrency must report the transaction—even if the “sale” was buying a cup of coffee with Bitcoin—and the tax owed depends on the difference between the cost basis and sale proceeds.
These calculations can be tricky for crypto-to-crypto transactions made across different exchanges and wallets. In addition to determining a fair value in U.S. dollars for the purchase and sale, taxpayers must match transactions between wallets and exchanges and choose an optimal accounting method to reduce your capital gains tax rate on the transaction.
Crypto accounting software simplifies the process by aggregating transactions across wallets and exchanges, as well as automatically computing capital gains and losses. You don’t have to worry about exporting these transactions from various locations and spending hours (or billable hours) reconciling them by hand—an error-prone process to be sure!
What Crypto Tax Accounting Features Do You Need?
There are many different crypto accounting solutions that can help you prepare taxes. While these platforms share some features, there are important differences that can have a big impact on everything from tax savings to audit defense. When choosing between solutions, you should carefully consider the features that you need.
Some basic features to look for include:
- Compatibility. Ensure that the crypto accounting software that you use supports all of the wallets and exchanges that you use.
- Transparency. Crypto accounting software should be transparent in how it computes capital gains and losses to provide an audit trail.
- Autofill. Some crypto accounting solutions will autofill popular IRS tax forms to simplify the entire process and minimize the potential for errors.
You might also look for some advanced features:
- Tax loss harvesting. Tax loss harvesting tools enable you to reduce taxes by realizing losses (and replacing them) to offset capital gains.
- Accounting methods. There are several different account methods—such as FIFO or LIFO—that may provide ways to reduce tax exposure.
- Integrations. Integrations with tax software, such as TurboTax, may be helpful for individuals that use those software applications to minimize errors.
The right decision depends on your individual situation. If you use a single crypto exchange, such as Coinbase, you may only require a very basic solution. If you make thousands of trades per year across many exchanges, you may require a much more complex solution that provides a lot of integrations and other features to maximize your tax savings.
How to Think About Cost
There are a couple of different ways to look at cost: You can look at the price tag as an upfront cost or you can look at the value as a long-term cost. Of course, most savvy consumers know that the value is the most important cost since it factors in potential cost savings. In other words, the best value is more important than the lowest price tag.
The value of cryptocurrency accounting software includes a few key factors:
- Avoid overpaying. Many taxpayers that received a Form 1099-K from exchanges, like Coinbase, overpaid their taxes because it omitted cost basis information. Without a cost basis, many taxpayers made higher assumptions than the reality of their cost basis and ended up paying more taxes than they were required to pay.
- Audit defense. Depending on the scope of an audit, taxpayers can end up spending money on accounting fees, penalties and interest. Simple audits can cost between $2,000 and $3,000 while complex audits can cost upwards of $7,500 with appeals and U.S. tax court fees compounding those amounts even more.
- Tax savings. Tax loss harvesting and other tools can help maximize tax savings through creative accounting techniques. Without the restrictions associated with equities, these strategies can help save hundreds or thousands of dollars per year on taxes, which simply isn’t possible without the use of these tools.
When evaluating different crypto accounting solutions, you should carefully consider the value rather than the cost. Crypto traders with a lot of trades and tax exposure could see a much greater value despite higher costs while individuals with smaller and simpler accounts may care more about the price tag given the limited value.
ZenLedger & Other Crypto Tax Solutions
ZenLedger makes it easy to aggregate transactions across exchanges and compute your capital gains taxes. In addition, the platform auto-fills popular IRS forms, such as Form 1040 Schedule D and Form 8949, and if you use TurboTax, provides a simple integration.
The platform also includes several other unique features:
- FinCen reporting. U.S. taxpayers are required to report holdings in foreign exchanges over $10,000 to FinCEN. ZenLedger automatically calculates the value of your holdings in foreign exchanges, alerts you if you’re required to file paperwork and guides you through the process of completing the necessary forms.
- EOS ICO to Mainnet support. Pre-ICO EOS transactions are tricky to patch together. ZenLedger accurately tracks EOS coins if they were unstaked or if you moved them between ETH and EOS wallets, enabling you to accurately report taxes.
- Tax loss harvesting. Tax loss harvesting can help you reduce your capital gains tax exposure. ZenLedger lets you know how many unrealized capital losses you have in each token type to help you prioritize tax loss harvesting transactions.
- Transaction drill-in. Blackbox algorithms can be a problem in the event of an IRS audit. ZenLedger provides a comprehensive spreadsheet export that shows every transaction and how taxes were calculated to help your accountant fill in the blanks, as well as efficiently defend yourself during an IRS audit.
There are also several other solutions out there:
The Bottom Line
Cryptocurrencies are becoming increasingly popular among Americans, but they’re also complicating taxes. Fortunately, cryptocurrency accounting software can simplify the process and ensure that you accurately report taxes and avoid overpaying. When choosing between different solutions, it’s important to consider your unique requirements.
Sign up for ZenLedger to see how easy it is to file your crypto taxes and ensure that you meet IRS requirements.