As the crypto market bursts through the $2.5 trillion market cap and BTC soars past $73,000, it’s important to consider tax implications, no matter how much of a killjoy that might be.When it comes to generating wealth with crypto assets, any missteps that follow when reporting crypto transactions can result in significant penalties owed to the IRS.
As such, it is vital that crypto investors, whether investing one dollar or $1,000,000, navigate their tax responsibilities meticulously.This article dives into the top three mistakes seen when it comes to crypto taxation, and offers guidance on how to avoid these potentially costly pitfalls.
Mistake 1: Underreporting Crypto Transactions One of the most common oversights that crypto investors fall prey to is underreporting their crypto transactions.Regardless of whether this mistake is caused by a misunderstanding of personal tax obligations or simply poor monitoring of transactions, a failure to report all crypto transactions correctly can quickly result in financial punishments imposed by tax authorities.
The Risks By underreporting crypto transactions, investors open themselves up to a number of both financial and legal penalties, such as interest owed on taxes, and extra fines.As crypto popularity is snowballing in 2024 due to the Bitcoin halving , the IRS is becoming ever-more vigilant in response.
In fact, the IRS is hiring crypto experts , leveraging increasingly-advanced technologies to discover inconsistencies in tax records, and cracking down on underreporting to ensure tax compliance.
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To overcome this issue, there are many tax record software options available to maintain detailed records of transaction amounts, dates, and more.
Mistake 2: Neglecting To Report Airdrops And Forks Airdrops and hard forks both involve the distribution of new cryptocurrencies among existing holders of the relevant crypto tokens.Though free tokens seem at first like a no-lose lucrative event, they still carry tax implications that many investors make the mistake of overlooking.
The Risks Investors that fail to report income received via airdrops and forks can end up facing unpleasant penalties and liabilities.
Both distributions are counted as ordinary income by the IRS and are considered taxable at the value of the crypto at the time the tokens were received.
With examples such as the huge Arbitrum ARB airdrop in March 2023, the financial gains for some also brought some heavy implications, requiring receivers of the airdrop to pay tax on their airdropped tokens.
How To Avoid The Risks Compliance is vital when it comes to crypto received through airdrops and forks.
To ensure investors keep up-to-date with how tax should be applied to their assets, consulting with a tax professional is a must.Their expertise in cryptocurrencies provide much-needed clarity to make sure airdrop and fork receipts are reported accurately on annual tax documents.
I spoke with Lance R.Drury, Attorney at Law and owner of U.S.-based tax firm Lance Drury Law , to discuss his perspective as a professional outside of the crypto space.
He had this to say: “Tax, under the watch of the IRS, particularly crypto tax, is full of pitfalls that could otherwise be avoided with accurate record-keeping.With tax regulations constantly evolving, especially in the crypto space, it can be hard to keep up.Every year something is different or more complicated.It’s of the highest importance to keep up with every little detail, so you don’t get hit with surprising fines or penalties come tax season.”
Mistake 3: Failure To Understand Tax Liabilities Another common mistake made by crypto investors is the failure to understand that taxation on crypto transactions is not limited purely to the buying and selling of cryptocurrencies.
Spending BTC at retailers that accept it and even swapping one cryptocurrency for another can result in tax liabilities, each activity with different implications on taxation.
The Risks Considering the intricacies presented by tax laws when it comes to the trading, swapping, and spending of cryptocurrencies, investors can quickly become overwhelmed by unexpected tax bills.
When swapping , for example, BTC for ETH ETH , the IRS considers it taxable — despite no involvement of fiat exchange occurring.Therefore, when carrying out numerous crypto swap transactions, the tax implications can quickly stack up.
How To Avoid The Risks As with the previous two considerations, the third is no different.Understanding current tax implications at every step of the way can mean the difference between paying more tax or, even, paying less.
Due to the FMV ( fair market value ) of traded crypto usually being calculated in U.S.dollars at the time of transaction, detailed record-keeping helps investors assess both their capital gains and losses.
If ultra-prepared beforehand — whether with the aid of a crypto-educated tax attorney or financial advisor or not — losses experienced as the result of token swaps can even become an advantage.According to Investopedia, it is possible to reduce the total taxes owed through such losses.
In my discussion with the Founder of TheFinanceNewsletter.com, Andrew Lokenauth, he shared, “Losing money in the market is no fun.But come tax time, those losses can help put cash back in your pocket.That makes now a good time for folks who lost money investing to save on what they owe the IRS.With the new year around the corner, the declines we’ve seen in the markets could help lighten tax burdens.”
Navigating Shark-Infested Waters The crypto space may offer a seemingly-untapped world of lucrative opportunity, but it is important to remember the implications of crypto taxation.As such, investors must be aware of the pitfalls of underreporting of transactions, the risks of neglecting to report airdrop and forks, and fully comprehend the annually-changing tax liabilities that crypto faces.
By adopting meticulous record-keeping of all crypto transactions, staying informed on current tax regulations, and seeking appropriate professional tax advice some tax season, investors can trade with confidence.
To keep up with the latest on crypto taxation, investors can always visit the IRS’s Virtual Currencies FAQ page .
Victoria Chynoweth.
