How Cryptocurrency Is Taxed: Five Common Crypto Tax Mistakes

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by: Guest Author

How Cryptocurrency Is Taxed: Five Common Crypto Tax Mistakes

Tax filing is a cake-walk — said no one ever! But more than its complications, what makes it difficult are the misconceptions that taxpayers have around how cryptocurrency is taxed.

So let’s take a look at how cryptocurrency is taxed in the USA and learn about crypto taxes from the five major misconceptions and mistakes that most crypto taxpayers face.

How Is Crypto Taxed In The US

Cryptocurrency is classified as property for taxes, according to the Internal Revenue Services standards from 2014. This means that capital gains or losses resulting from the sale of your assets are taxable, whereas assets you simply keep or possess are not taxable until they are sold. 

Mistake #1. Missing Trade History

First things first. In order to calculate your capital gains and losses, it is important to know the cost basis of your crypto assets. But it must be noted that the cost basis is not the same at all times since it varies according to the date of acquisition.

When you fail to include this crucial information when cryptocurrency is taxed, you might end up paying higher taxes than you’d have to pay otherwise.

Tax Tip

Most taxpayers fail to provide a complete track history of the previous years only as they only have a record of a year’s transactions. Make sure that you have a complete record of all your cryptocurrency transactions of all previous years when you’ve held your crypto assets.

Mistake #2. Not Mentioning Forks and Airdrops

Crypto transactions are of two types, taxable and non-taxable events. You might receive crypto for free by means of airdrops or by hard fork. It’s also crucial to comprehend the tax ramifications of a cryptocurrency hard fork. But what is a hard fork, exactly? 

It is fairly typical for developers to make updates or upgrade the programming of a cryptocurrency after it has been available for a time. A “hard fork” occurs when a cryptocurrency program or “protocol” receives a significant upgrade or coding revision.

But where most people go wrong is that they do not mention the coins received in these events in their tax report. Thus, they end up paying more tax than usual.

Tax Tip

You must classify your full crypto transaction history, even if you’ve received it for ‘free’. If not, you might end up paying much higher taxes.

Mistake #3. Report Mining Income Correctly

Although mining Bitcoin is not a traditional profession, the benefits you obtain are obviously taxable income in the perspective of the IRS. Bitcoin miners currently receive 6.25 BTC for mining one block of bitcoin, which is worth around $272,000 at current prices. The IRS wants you to report this as ordinary income on your tax return. 

Tax Tip

You may have to pay self-employment tax on those Bitcoin rewards, depending on how your firm is set up. If you work as an employee for a cryptocurrency mining company, the money you earn from that employment is taxable, too, even if it’s in bitcoin.

Mistake #4. Not Mentioning Received Crypto As Income

Many fintech companies are offering new customers free crypto as a sign-up benefit as they aim to attract revenue to their cryptocurrency trading systems. They may also offer incentives to users who refer others to the platform.

Tax Tip

The IRS considers these payouts to be income, so when they show in your account, it’s a taxable transaction. Even if your company doesn’t record this transaction to the IRS — which is unlikely given how loose crypto reporting is — you must still declare it as income to the IRS.

Mistake #5. Only Paying At Cashing Into Fiat Currency

The fifth misconception among taxpayers is that you only need to pay taxes when you cash out your crypto into fiat currency. This, however, is not the reality. There are many distinct events and situations that can be taxed. Did you, for example, trade any cryptocurrencies?

Trading between various cryptocurrencies (e.g. Bitcoin to Ethereum) will result in a capital gain. Even if the taxpayer chooses to classify their trades as like-kind, it’s uncertain whether the IRS will accept their claim. 

Tax Tip

If the IRS rejects your claim for like-kind treatment, you’ll be charged penalties and interest on the unpaid tax.

Final Thoughts: Harvesting Tax Losses

Tax-loss harvesting is a practice that involves selling crypto at a loss to reduce your declared capital gains. In order to reduce their tax payment, smart investors would often do this close to the end of the year.

However, there are four considerations to keep in mind before harvesting losses:

  • In 2022, a proposal to apply the wash sale rule to bitcoin could become law. If this rule is implemented, you will be unable to deduct a loss from a cryptocurrency sale if you buy the same cryptocurrency 30 days before or after the sale.
  • It’s important to remember that balancing your short-term gains comes first.
  • It’s a good idea to harvest your losses all year long.
  • Don’t forget to factor in exchange rates.

FAQs

 

  • How is cryptocurrency taxed in the USA?

 

The IRS, in the year 2014, issued a Notice 2014-21 which stated that cryptocurrency is classified as property for taxes. This means that capital gains or losses resulting from the sale of your assets are taxable, whereas assets you simply keep or possess are not taxable until they are sold. 

  • What are common tax mistakes?

More than its complications, what makes it difficult are the misconceptions that taxpayers have around how cryptocurrency is taxed. Some of the most common tax mistakes are-

  • Missing trade history
  • Not mentioning forks and airdrops
  • Report mining income incorrectly
  • Not mentioning received crypto as income
  • Only paying tax at cashing into fiat currency
  • What is the penalty for an incorrect tax return?

According to the IRS, the penalty is normally 5% per month or part of a month that a return is late, but it cannot be more than 25%. The penalty is dependent on the amount of tax that has not been paid by the due date (without regard to extensions).

  • Can you still tax loss harvest crypto?

Tax-loss harvesting is a practice that involves selling crypto at a loss to reduce your declared capital gains. In order to reduce their tax payment, smart investors would often do this close to the end of the year.

However, there are four considerations to keep in mind before harvesting losses:

  • In 2022, a proposal to apply the wash sale rule to bitcoin could become law. If this rule is implemented, you will be unable to deduct a loss from a cryptocurrency sale if you buy the same cryptocurrency 30 days before or after the sale.
  • It’s important to remember that balancing your short-term gains comes first.
  • It’s a good idea to harvest your losses all year long.
  • Don’t forget to factor in exchange rates.

 

Disclaimer

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