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Costly Crypto Tax Mistakes to Avoid When Filing Your Crypto Taxes
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Common crypto tax mistakes include ignoring or misreporting airdrops, guessing cost basis, not filing because you can't pay, and failing to report all transactions.
Assume that the IRS has full transparency into your crypto activity and report all crypto transactions accurately to avoid penalties, interest, and potential criminal charges.
Is the IRS keeping track of my crypto wallet?
It’s best to assume the IRS has full transparency into your crypto activity. The IRS has the ability to monitor cryptocurrency activities by compelling crypto exchanges and trading platforms to submit tax forms such as 1099-B and 1099-K.
Beyond this, numerous exchanges have been served with subpoenas that require them to disclose specific user accounts. These measures enable the IRS to ascertain the frequency of cryptocurrency transactions among US taxpayers and identify instances where reporting was omitted.
What happens if I file my crypto taxes wrong?
If you’ve neglected to properly report crypto on your taxes, don’t panic. You will likely be able to amend your returns, and it is better to file crypto taxes late than not at all and to avoid crypto tax mistakes when you refile. The IRS offers clear guidance on amended returns.
Failure to accurately report crypto taxes can have serious consequences. These vary by region, but as a rule, it’s essential that taxpayers report crypto on their returns in order to avoid penalties, interest, and even criminal charges. For more details, read our comprehensive article about what happens if you don’t report crypto taxes.
Common and costly crypto tax mistakes to avoid the next time you file your taxes
Here are some common, and potentially expensive, crypto tax mistakes you’ll want to avoid during tax season. The surest way to avoid crypto tax mistakes is to work with our platform and expert team at TokenTax.
Underestimating the IRS’ ability to trace your crypto activity
It’s best to assume the IRS has a complete record of your crypto activities, whether on centralized exchanges or in DeFi. In its efforts to intensify scrutiny of cryptocurrency transactions, the IRS has sought guidance from multiple blockchain companies to proactively adapt to evolving developments within the system.
The IRS leverages data analysis, pattern recognition, and machine learning techniques to detect potentially illegal behavior spanning numerous exchanges and billions of transactions. This is one key reason it’s essential to avoid crypto tax mistakes when filing.
Ignoring or misreporting airdrops
Funds received from an airdrop or hard fork are taxed as ordinary income. This income should be reported at the value of the asset when you took full control of it. The IRS has addressed how to treat airdrops and hard forks.
The IRS’ 2019 guidance clarifies that airdrops and hard forks are taxed as ordinary income, at the market value the asset had when you received and took complete control of it. This means that if you receive tokens from an airdrop—whether you wanted to or not—you must report them on your tax return.
Guessing or averaging cost basis
Knowing your crypto cost basis is crucial for assessing the tax implications of cryptocurrency transactions. Cost basis denotes the initial purchase price of a crypto asset, including associated fees, and serves as the basis for calculating capital gains or losses.
Maintaining accurate records of your crypto transactions using specialized tax software like TokenTax enables you to effectively determine your cost basis, ensuring accurate tax filings and mitigating the risk of penalties resulting from inaccurate reporting.
Not filing because you can’t pay
Crypto is famously volatile and can be stressful, particularly when the market takes a turn for the worse. That said, it’s essential to file your crypto taxes even in circumstances that are less than ideal.
Failure to pay your taxes on time may cause the filing of a Notice of Federal Tax Lien and/or an IRS levy action. The IRS offers payment plans for those who need more time to pay their tax bills.
Not claiming capital losses
The IRS requires taxpayers to report crypto losses using Form 8949 and 1040 Schedule D. Claiming crypto capital losses on your tax return may allow you to deduct them from your income or offset capital gains, lowering your tax liability.
You can typically use crypto losses to offset capital gains (including future capital gains if there is applicable carryover) and/or to deduct up to $3,000 from your income.
Failure to report every crypto transaction
All crypto transactions, including trades, sales, and even small purchases, must be reported. Neglecting to include transactions can result in underreporting and potential penalties.
TokenTax makes it simple to ensure a thorough crypto tax filing. With our platform, you can import data from every crypto exchange, blockchain, protocol, and wallet. Just sync your transactions via API or upload them in a supported CSV format.
Ignoring crypto-to-crypto trades
Crypto-to-crypto trades are taxable events and must be accounted for. Each trade needs to be evaluated for its fair market value at the time of the transaction to determine any capital gains or losses.
To avoid crypto tax mistakes when reporting, keep detailed records of your crypto-to-crypto trades, including the dates, values, and associated transaction fees. These records help to ensure your tax calculations are accurate and complete. When in doubt, our expert team at TokenTax can assist.
Overlooking tax obligations for mining or staking rewards
If you receive mining or staking rewards, they are typically considered taxable income (for US taxpayers) and are also subject to capital gains tax when you dispose of them. When you receive mining or staking rewards, they are typically considered part of your taxable income for the year.
Beyond this, when you dispose of the mining or staking rewards by selling for fiat or exchanging them for other cryptocurrencies, resulting capital gains are also subject to capital gains tax. The capital gains tax is calculated based on the difference between the fair market value of the rewards at the time of acquisition and their value at the time of disposal.
Failure to report foreign crypto exchange activity
If you use offshore crypto exchanges, you still need to report those transactions to the tax authorities in your jurisdiction. The IRS is increasingly focused on cryptocurrency transactions and has implemented measures to track and identify individuals who fail to report their crypto activities, even if conducted on foreign exchanges.
If you are uncertain about the specific reporting obligations for foreign crypto exchange activity in your jurisdiction, consult with a crypto tax professional who specializes in cryptocurrency taxation.
Relying on exchange-provided tax documents
While exchanges may provide tax documents, it is necessary to cross-check and ensure their accuracy and report all crypto activity whether or not you receive tax documents from exchanges.
Whether or not you’ve received documents from an exchange, it’s your responsibility to report every crypto transaction, including those on decentralized exchanges.
Neglecting to report crypto-related income
Income from activities such as crypto lending, staking, or airdrops must be reported as taxable income and their disposals for corresponding capital gains or losses.
Similar to mining or staking rewards, this means you need to keep a complete record of both the fair market value of crypto income at time of receipt in addition to your gains or losses from later disposal of crypto initially received as income.
Frequently asked questions about crypto tax mistakes
Here are answers to questions about common crypto tax mistakes and how to avoid them.
Is there a way to legally avoid crypto taxes?
While it’s impossible for most taxpayers to totally avoid crypto taxes when trading crypto, there are legal ways to reduce your crypto tax liability. To minimize crypto taxes, taxpayers can tax loss harvest, use crypto tax software like ours at TokenTax, make crypto donations, favor long-term capital gains, and sell during a low-income year.
What happens if I get audited by the IRS
Failure to properly report crypto to the IRS can result in penalties, fines, and criminal charges. Guidance from crypto tax professionals and the use of crypto tax software like ours at TokenTax can help ensure compliance and accurate reporting.
If selected for an audit, the IRS will send a letter, and the audit will be conducted through mail or face-to-face interviews. The IRS requires taxpayers keep tax records for at least three years, and audits can in fact cover returns for the previous six years.
Will I get in trouble for not filing crypto taxes?
In all likelihood, failure to report crypto taxes will result in consequences including fines, penalties, and even criminal charges. The IRS randomly audits taxpayers, and if you’re active in crypto and fail to report, this could be considered a red flag and result in additional scrutiny and an audit.
Will I get audited if I don't report crypto?
IRS audits can be random or triggered by suspicious activity, which of course taxpayers should do everything in their power to avoid. Failure to report crypto activity or inaccurate reporting could trigger an audit.
Can the IRS audit cryptocurrency?
Yes, the IRS can and will focus on crypto activity during an audit. Crypto-specific activity that might trigger a crypto audit includes:
Failure to accurately report crypto transactions and income.
Large transactions or significant gains.
Inconsistencies or discrepancies.
Use of privacy-focused coins.
Participation in offshore exchanges.
Taxpayers can ensure thorough crypto tax filings and avoid audits with crypto tax software and trained experts like our team at TokenTax.
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