The IRS’ Taxing Effort To Monitor Crypto Activity: What You Need To Know

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U.S. taxpayers have just a few more days before the tax deadline. What makes this year different from most tax years is one little question the IRS has added to the tax form: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any virtual currency?”

If you bought any cryptocurrency during 2021 and held onto it without selling it, just check the “No” box and that’s all you are required to do. However, if you were paid in cryptocurrency for work you performed; sold cryptocurrency; traded crypto; or gifted, “burned,” or donated cryptocurrency, then you must check the “Yes” box and report on your crypto activities. If you check the “No” box when you did sell, trade, or dispose of a cryptocurrency during the 2021 tax year, you could face stiff penalties under perjury laws.

How Cryptocurrency Is Taxed

A “taxable event” is defined as any activity that results in taxes owed. Whether talking about cryptocurrencies or dollars, there are different taxable events. 

When it comes to income taxes, there are three general types of taxable events:

  1. Earned income

  2. Capital gains

  3. Gifts and donations

Earned Income

Earned income is any income you receive for work performed. For instance, if you work for a company that pays wages in cryptocurrency, either in part or in whole, then any cryptocurrency you receive as payment in wages is considered earned income. That can be an hourly wage, a salary, or commissions. Even tips. For freelancers, if a client pays you in crypto for services you perform, that’s also earned income.

Whatever you would report as earned income regarding dollars and cents, you should also report as earned income regarding cryptocurrencies.

Capital Gains

Capital gains are taxed differently than earned income. For that reason, you’ll want to keep track of your capital gains on crypto. But there are two different types of capital gains: Short-term gains and long-term gains.

Short-term gains are any gains you receive within a 12-month period. Long-term gains are capital gains you receive beyond 12 months.

For instance, if you bought bitcoin in January 2021 and sold it in November 2021 realizing a $20,000 gain, your capital gains tax will be higher due to its short-term duration than it would be if you had realized the same $20,000 after buying bitcoin in January 2020 and selling it in November 2021. You can mitigate your taxes simply by holding a cryptocurrency for more than a year before selling or trading it.

Another taxable event than can trigger a capital gain is buying something with your cryptocurrency. The IRS doesn’t care whether you sell your crypto or buy a Tesla. In either case, it’s a taxable event and it will result in capital gains.

If you trade one cryptocurrency for another, that’s also a taxable event and will result in capital gains. Whether it is a short-term gain or a long-term gain depends on the length of time that you hold the asset.

Be sure to consult a tax accountant familiar with cryptocurrencies if engaged in a lot of crypto trading in 2021.

Gifts and Donations

Crypto donations, like dollar donations, are tax-deductible. There are limits to how much you can write off based on adjusted gross income, so consult a tax accountant and keep good records. 

Gifting cryptocurrencies is also a taxable event. However, if your gift is smaller than $15,000, then you will not have to pay the gift tax.

How Likely Is It That You’ll Be Audited?

While tax audits are always possible, the IRS is short-handed and struggling to hire enough personnel to handle the tax backlog they have now. The IRS has 7.1 million individual tax returns from last year that still have not been processed. That’s a huge backlog.

If your game plan is to rely on that backlog in hopes that you can get away with not reporting your crypto, you may want to speak with a tax accountant or tax attorney first. The IRS is planning to hire 5,000 additional personnel to handle the backlog and handle returns filed for 2021. While short-staffed, the agency will likely continue to issue audit notices and may decide to target crypto users.

The IRS is fighting stiff competition for workers, but the agency expects to eliminate its backlog by the end of 2022.  

 

To learn more about IRS tax audits, consult the IRS website.

 

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