Key Points
The IRS treats cryptocurrency as property, making it subject to capital gains tax, and non-compliance can lead to penalties and criminal charges.
The IRS is tightening cryptocurrency reporting regulations, as evidenced by high-profile cases like the 2018 Coinbase lawsuit.
Proper cryptocurrency tax reporting involves identifying transactions, calculating gains and losses, filling out correct forms, and consulting with a tax professional if needed.
In the ever-evolving world of finance, cryptocurrency has firmly established its footprint. For some, cryptocurrencies' anonymous, decentralized, and volatile nature can potentially provide an investment prospect. However, just as with any other form of asset, it's crucial to remember that these digital coins carry tax implications. In fact, the Internal Revenue Service (IRS) classifies cryptocurrency as property for tax purposes, making it subject to capital gains tax.
The popularity of these digital currencies has exploded over the past few years, leading to a widespread misconception that cryptocurrency exists in a sort of tax-free digital bubble. This is not the case. Failing to report crypto holdings, trades, and transactions on your tax returns can lead to a hefty penalty or in extreme cases, even criminal charges. Therefore, the importance of appropriately reporting cryptocurrency on your tax returns cannot be overstated.
Cryptocurrency and Its Tax Implications
At its core, cryptocurrency is a digital or virtual form of currency that relies on encryption techniques to secure transactions, control the creation of new units, and verify the transfer of assets. Unlike traditional currencies such as the dollar or euro, cryptocurrencies like Bitcoin and others operate on a decentralized platform known as blockchain.
From a tax perspective, the IRS treats cryptocurrencies as property, much like stocks or real estate. This means that the principles applicable to property transactions also apply to transactions using virtual currency. If you sell, exchange, or use cryptocurrency to buy goods or services, you could potentially trigger a taxable event resulting in capital gains or losses. These need to be reported on your tax return. If you are paid in cryptocurrency for goods or services provided, it's treated as income and is subject to income tax.
What Happens If I Don’t Report Crypto On Taxes?
Failing to report your cryptocurrency transactions on your taxes can lead to significant consequences. The IRS has been progressively tightening the regulations around cryptocurrency reporting, and neglecting your obligations can trigger hefty penalties.
Financial penalties are the most immediate repercussion. The IRS can charge a negligence penalty along with late payment penalties and interest on any unpaid taxes. The exact amount depends on the severity of the infraction and the amount of tax underpayment.
The IRS doesn't stop at financial penalties. In severe cases, failure to report cryptocurrency on taxes can also lead to criminal charges such as tax evasion or filing a false return, both of which carry hefty fines and possible imprisonment. The IRS has made it clear that it is committed to ensuring compliance with existing tax laws in the area of digital currencies.
Coinbase
There have been several high-profile cases in the past where individuals faced serious consequences for not reporting their crypto transactions. For instance, in 2018, a California court ruled in favor of the IRS in a lawsuit against Coinbase, one of the largest cryptocurrency exchanges in the world. The court ordered Coinbase to turn over identifying information for accounts with more than $20,000 in annual transactions between 2013 and 2015. This case was a clear signal that the IRS is actively pursuing individuals who fail to report their cryptocurrency transactions.
It's important to note that while cryptocurrencies offer a degree of anonymity, this should not create a false sense of security. All transactions on the blockchain are public and traceable, and large cryptocurrency exchanges may report high-value transactions to the IRS.
Potential Criminal Penalties For Crypto Tax Evasion
The U.S. tax system is built on voluntary compliance, and there are stringent penalties in place for those who choose to bypass this system. If you choose to evade taxes, particularly by failing to report your cryptocurrency transactions, you could face serious criminal charges. These can range from tax evasion and filing a false return to conspiracy to defraud the United States, all of which are felonies.
For tax evasion, you could face a prison term of up to five years and a fine of up to $250,000 for individuals or $500,000 for corporations. If charged with filing a false return, penalties can include a prison term of up to three years and a similar fine. In addition, anyone convicted of tax evasion may also be ordered to pay the costs of prosecution.
It's also important to understand the statute of limitations for tax evasion. Generally, the IRS has a three-year window to audit a tax return. However, if the IRS can prove you significantly underreported your income (by more than 25%), that window extends to six years. For those suspected of filing a fraudulent return or willfully attempting to evade tax, there is no statute of limitations — the IRS can investigate at any point.
How to Properly Report Cryptocurrency on Your Taxes
Identify your transactions: Your first step should be to compile a record of all your cryptocurrency transactions from the past year. This includes not just sales, but also purchases, exchanges (even between different types of cryptocurrency), and income received in the form of cryptocurrency.
Calculate your gains and losses: Next, calculate your capital gains or losses. This is done by subtracting the cost of acquiring the asset (the 'cost basis') from the sale price. Remember to take into account transaction fees and other related costs.
Fill out the correct forms: In the U.S., you report your transactions on Form 8949 and summarize your capital gains or losses on Schedule D, which you attach to your Form 1040 tax return. You need to report each transaction individually on Form 8949.
Include cryptocurrency income: If you've earned cryptocurrency through mining, staking, airdrops, or payment for services, this counts as taxable income and should be reported on your return.
To assist with these steps, it may be helpful to use a cryptocurrency tax software platform that syncs with various exchanges and wallets, compiling your transactions and calculating your capital gains or losses.
For complicated situations, or if you're unsure about any aspect of reporting cryptocurrency on your taxes, it might be wise to consult with a tax professional who has experience with cryptocurrencies.
Bottom Line
What happens if I don’t report crypto on taxes? For individuals who trade or invest in cryptocurrencies, it's crucial to maintain thorough records of all transactions. These records will play a crucial role in accurately calculating capital gains or losses and subsequently reporting them on your tax returns. Moreover, given the complexity and rapidly changing landscape of cryptocurrency regulation, it's recommended to seek professional assistance.
Tax professionals or tax software can be invaluable in helping to navigate the intricate world of cryptocurrency taxation. They can ensure compliance, help optimize tax strategies and avoid potential legal repercussions. Remember, the benefits of being tax-compliant far outweigh the potential consequences of failing to report your cryptocurrency transactions.