Top 10 Crypto Tax Mistakes and How to Avoid Them

By Kriss
Published on: August 5, 2021

Investing in Bitcoin or being paid in cryptocurrency may seem like the best idea since sliced bread or the worst possible use of your money, depending on the month, day, hour, or minute you check the headlines. Whether you agree with Warren Buffett that Bitcoin has “no value” or believe Bitcoin will reach $300,000 in 2022, one thing about cryptocurrency is undisputed: getting it correctly on tax returns has never been more important.

The Internal Revenue Service (IRS) is working hard to identify and prosecute US taxpayers who are obligated to record cryptocurrency transactions but do so improperly or completely remove cryptocurrencies from their tax returns. It’s never been more vital to understand the tax ramifications of purchasing, selling, exchanging, or earning Bitcoin. We’ve discovered ten typical errors people make when reporting (or not reporting) Bitcoin transactions to the IRS, and we’ll go over how to prevent each one in its own piece.

1. Cryptocurrency is not reported at all.

The most common mistake taxpayers make when it comes to taxes and cryptocurrencies is failing to disclose crypto transactions at all, whether intentionally or unintentionally. When it comes to crypto investors who aren’t declaring income, Carolyn Schenk, the National Fraud Counsel & Assistance Division Counsel for the IRS Office of Chief Counsel, says, “We see you.”

2. Crypto-to-Crypto transactions aren't being reported

In a coin-to-coin transaction, crypto investors commonly trade one cryptocurrency for another. It’s critical to recognize that these are taxable occurrences that must be reported.

3. Failure to take appropriate steps to transfer your cryptocurrency upon your death or disability

Do your family members know how to get into your cryptocurrency accounts? Even if your loved ones can’t access or unlock the value of your Bitcoin, the value of it may be included in your taxable estate if you die or become handicapped. We’ll look at the best methods for ensuring that your loved ones aren’t left to clean up your crypto mess without access to the asset’s worth.

4. Reporting crypto with like-kind exchanges

To be honest, this isn’t anything I’ve ever seen one of my clients do. However, because crypto held as an investment must be reported as property, crypto trades for property, such as a Tesla or exchanging Bitcoin for Ethereum, should qualify for a like-kind exchange under section 1031 of the Internal Revenue Code. Regrettably, it does not.

5. Failure to calculate cryptocurrency gains and losses correctly

Have you ever made a cryptocurrency loss? Losses and profits have to and should be reported to the IRS, and losses can often totally balance the tax effects of gains. However, even if they do, taxpayers must still record the transactions. Cryptocurrency investors are not only obligated to record and pay taxes on gains, but they also need to factor in losses when determining their tax liability.

6. Failure to prepare and maintain appropriate crypto transaction records

Taxpayers must be able to demonstrate basis in an asset, including cryptocurrencies, in order to calculate the gain or loss and the resulting tax due, just as they must with any taxable sale or exchange of property. Taxpayers who don’t keep excellent records may end up paying tax on cryptocurrency sales as if they had no basis in the asset at all. Taxpayers should avoid being misled into complacency by assuming that all records would be available electronically when tax season arrives.

7. Failure to report cryptocurrency transactions for goods and services

Consider using Bitcoin to pay for your new outdoor furniture from overstock.com. Taxpayers should be aware of the tax ramifications and reporting obligations involved with paying with Bitcoin as more retailers accept it.

8. Reporting cryptocurrency as earned income incorrectly

The sale of cryptocurrency kept for investment is not taxed the same way that cryptocurrency obtained in exchange for performing services is. We’ll look into and discuss how Bitcoin income should be taxed.

9. Reporting cryptocurrency transactions on the wrong form

Are you getting paid in crypto? Have you ever traded a car for cryptocurrency or vice versa? Are you merely speculating in cryptocurrency? Are you a crypto miner? Each of these potential transactions may necessitate the completion of a separate IRS form in order to appropriately record the transaction and calculate the tax implications.

10. Reporting cryptocurrency received through airdrops, forks, and splits incorrectly

Air-drops, forks, and splits may be unfamiliar concepts to new cryptocurrency investors, but they are vital terms for anyone dabbling in the space to understand since they have tax ramifications. We’ll help you sort through the complexities of these occurrences and how they affect your tax reporting obligations with Revenue Ruling 2019-24, which expressly tackles these knotty concerns.

Conclusion

I don’t get to decide how the IRS will handle increasing and improving outreach to taxpayers who should be reporting cryptocurrency transactions on their tax returns, and I don’t get to decide how the IRS will bring those taxpayers into compliance because I’m not the Commissioner of the Internal Revenue Service. However, as a tax litigator, I have a lot of suggestions about how the IRS should achieve these objectives. We’ll wrap up our series by looking at how the IRS has handled outreach and enforcement thus far, as well as what we’d like to see in the future.

Kiara Sofia Smith

My current focus is blockchain technology and cryptocurrency. One could even call me a blockchain “enthusiast.” I have worked for almost a decade on several financial projects related to the stock market news, fundamental research and technical analysis for several blogs.

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