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What happened

The extended deadline to file 2021 taxes (October 17, 2022) is approaching soon. If you still haven’t reported your cryptocurrency activity to the IRS, this is the last day to do so without incurring penalties.

Key Concepts

How are cryptocurrencies taxed?

Cryptocurrencies are taxed as goods according to the Tax Notice 2014-21. This tax treatment results in taxable events each time you cash in, spend, or trade one cryptocurrency with another. Earning interest, staking rewards, mining income and receiving airdrops are also taxable events.

Investors must pay capital gains taxes based on the difference between a coin’s selling price and the cost base (how much you paid for it). Interest, staking, mining and airdrops are subject to ordinary income tax at the time of receipt.

You must also report cryptocurrency-related losses on your taxes. These losses can offset your income and increase your overall tax refund.

Crypto is not invisible to the taxman

Many people mistakenly believe that regulators have no visibility into their crypto activity because blockchain transactions are pseudo-anonymous (or anonymous). However, this is not the case, especially when it comes to centralized exchanges such as Coinbase. The IRS is aware of cryptocurrency activity through exchanges reported to it (via 1099s) and information collected through subpoenas.

1099-Ks and 1099-Bs signal crypto transactions

If you receive a Form 1099-K or Form 1099-B from a crypto exchange, the IRS likely knows you have reportable cryptocurrency transactions. This is due to the “matching” mechanism built into the IRS Information Reporting Program (IRP).

Here’s how it works. In a tax year, if you have more than $20,000 in proceeds and 200 trades in a crypto exchange, you will receive a Form 1099-K showing the proceeds for each month. Exchanges are required to create these forms for users who meet the criteria. A copy of this form is provided to the account holder and another copy is sent to the IRS. If you file a tax return and do not include these amounts, the IRS computer system (Automated Underreporter (AUR)) automatically flags these tax returns for tax underreporting. This is how you get crypto tax notices like CP2000. If you receive a Form 1099-B or 1099-MISC and do not report it, the same principles apply.

Therefore, if you receive a tax form from an exchange, the IRS already has a copy and you should definitely report it to avoid tax notices and penalties.

Subpoenas

The IRS also relies on subpoenas to obtain information about non-compliant taxpayers. For example, in 2018, Coinbase had to disclose about 13,000 user accounts including tax identification number, name, date of birth, address, account activity records, transaction logs and any periodic account statements or invoices (or equivalent) pursuant to the John Doe summons. In 2021, the IRS issued subpoenas for Kraken & Circle. In 2022, SFOX was ordered to release information about some crypto users.

Which tax forms to fill out?

Form 8949 and Schedule D

Form 8949 is used to report your cryptocurrency and NFT gains and losses. If you receive a complete and accurate 1099-B from an exchange, you can enter those numbers on these forms. If you have traded NFTs, you will need to rely on your manual records or connect your hosted wallet (such as Metamask or Phantom) to cryptocurrency tax software to obtain the numbers needed to complete this form.

Schedule 1

Amounts reported to you by an exchange on Form 1099-MISC, such as staking income, interest income, and rewards income, would go to line 8z of Schedule 1. You must report this income even if you do not receive any tax forms. .

Form 1040 Crypto Question

Last but not least, be sure to answer the cryptocurrency question (“At any time in 2021, have you received, sold, traded, or otherwise disposed of a financial interest in a virtual currency?”) on the front and in the center of the Form 1040.

If you dealt with cryptocurrency in 2021, you will most likely need to check “Yes” for this general question. That said, you can safely tick “No” if you;

1) held coins in a wallet in 2021 (hodler)

2) transferred coins from one exchange/wallet you own to another exchange/wallet account you own in 2021.

3) bought cryptocurrency in USD in 2021.

Next steps

  • Compile your crypto tax records and complete the appropriate tax forms before the deadline to avoid penalties.

Further reading

Disclosure: This report is for informational purposes only and nothing is intended to construe financial or tax advice.



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