With the rise in the worth of cryptocurrency in recent years, it makes sense that people are beginning to add it to their investment portfolios. However, since cryptocurrency is fairly new, there are specific ways in which to report it on your tax return. Not submitting this information in the right manner or miscalculating it can lead to your tax return being selected for auditing, which can lead to penalties and fees if the IRS finds that you did not account for it correctly. Seeing a professional tax preparer can help and understanding the basic of cryptocurrency and taxes will as well.
What Is Cryptocurrency?
To put it simply, cryptocurrency is a form of money that doesn’t physically exist. This money lives solely in the digital realm and can be passed from person to person or purchased from an exchange or the stock market (for certain cryptocurrencies anyway) and placed in a digital wallet. You cannot walk into a bank and withdraw physical cryptocurrency like you can dollars. The most well-known form of cryptocurrency is Bitcoin, which started out as a currency that needed to be digitally mined. From there, it took off, and as people began buying and trading it, soared in price.
Due to the popularity of Bitcoin, other cryptocurrency creators followed suit, and there are now dozens of different types. Some are worth more than others, and various shops, restaurants, and online stores might accept one type of cryptocurrency or another, depending on their policies. What makes cryptocurrency interesting is not only the ways in which a person can obtain it – either through digital mining on a blockchain or through outright purchases – but the fact that it’s not backed up by any other means. What does this mean? Right now, the U.S. dollar is backed by physical means, so it won’t lose all of its value unless something catastrophic happens. However, cryptocurrency doesn’t have silver, gold, or anything else backing it, so if a form of it loses all of its value, then holders are left with nothing but some random numbers.
The mysteriousness of cryptocurrency, as well as the risks and rewards involved in investing in it have many people very interested in adding to their investment portfolio. If you choose to do so, then you need to report the investment to the IRS, as you would any other gains or losses that you make throughout the years on things like standard stocks and bonds.
Do I Need to Report It on My Tax Return?
The short answer here is: yes, you need to report any sales or purchases of cryptocurrency (referred to as digital currency on IRS tax return forms) that you make over the course of a year. Those purchases and sales are subject to taxation, much like the purchase or sale of other investments. Failing to properly report this information can lead to further headaches, such as IRS audits and having to pay fines and penalties for submitting an incorrect tax return.
How is Cryptocurrency Classified by the IRS?
The IRS views cryptocurrency as a property. It also classifies stocks and bonds in a similar manner. Since you have to buy or trade, in the parlance, digital currency through an online marketplace when you’re investing in it or sell it through it a similar internet-based marketplace when you’re divesting of it, just as you would a stock or bond, the IRS has placed it in a similar category. You’ll receive a tax reporting form at the end of the year that includes the amounts of purchases or trades and sales that you can use when filling out your federal, state, and local tax return.
How Do I Report My Cryptocurrency Dealings to the IRS?
The IRS makes it easy to report those cryptocurrency trades and sales by providing you with a form that gets submitted along with your tax return. Once you receive a 1099-K from the firm or company that you traded or sold the cryptocurrency through, which lists the amounts of the transactions, you can use that information to fill out a Form 8949. This form answers the question “at any time during [the year] did you receive, sell, send, exchange, or otherwise acquire any financial interest in digital currency?” If you’ve received a 1099-K form, then you must answer “yes” to this question and fill out Form 8949, which gets added to your IRS tax return. The IRS will then include that information when processing it, and even reach out to your cryptocurrency firm if needed in order to verify the amounts that you submitted on your tax return.
Do My Trades or Sales Need to be Above a Certain Threshold?
In order to receive a 1099-K from your cryptocurrency trading firm you need to meet several different specifications. They include:
- Making Upwards of 200 Transactions Throughout the Year – Some firms may have other requirements, but for the most part, in order to trigger the creation of a 1099-K form, you must have completed 200 different cryptocurrency transactions over the course of the year. This includes purchases and trades, as well as sales.
- Receiving Total Sales Proceeds of $20,000 Or More – Again, some firms may differ, but you can expect to receive a 1099-K form if your cryptocurrency sales proceeds add up to $20,000 or more in a given year. However, there are some other numbers that you need to know in order to see if you must report this information on your tax return.
- State Threshold Amounts – Certain states have lower reporting thresholds. This means that if your proceeds exceed that amount – even if they do not come close to the $20,000 amount – then you must ask for or receive a 1099-K form. The states that have these lowered thresholds include: Arkansas ($2,500); Washington D.C. ($600); Illinois ($1,000); Maryland ($600); Massachusetts ($600); Mississippi ($600); Missouri ($1,200); New Jersey ($1,000); Vermont ($600), and Virginia ($600). If you reside in one of those states and have proceeds in amounts over the threshold limits, then you must declare that information on your tax return on form 8949.
Is There Anything That Doesn’t Appear on a 1099-K Form?
While a 1099-K form includes plenty of information and is designed to help you properly report your cryptocurrency trading to the IRS, it doesn’t contain every bit of information that you may need. In some cases, you may need to reach out to your accountant or professional tax preparer in order to obtain all of the information that you need to report, such as your gains, losses, or cost basis for your cryptocurrency. This information will appear on a 1099-B form, although, since the IRS views digital currency as personal property, not standard stocks and bonds. Whether or not you receive a 1099-B form depends on the firm that you use for trading your digital currency. Some may send one out, while others may come to the conclusion that it falls under the personal property threshold and a 1099-B form is not needed. Since this varies considerably, check with your trading firm as well as the professionals that prepare your taxes. Your accountant may be able to help answer this question as well.
What Happens If I Don’t Report My Digital Currency Trades or Sales?
Failing to properly report your digital or cryptocurrency trades or sales on your tax return can lead to a number of issues with the IRS. To begin with, neglecting to mention the money made from these trades can affect the overall amount that you owe the IRS. If they notice that something seems amiss and choose to audit your return, they may find out that you did not include this information and hit you with fines, fees, or penalties on top of the amounts that you should have paid them had you submitted the information properly.
In order to prevent this from happening, you need to account for these transactions on your tax return. If you aren’t sure whether or not you made enough trades or received an amount of proceeds over the require threshold for the state in which you reside, you should see a tax professional. They can help you not only determine whether or not you need to report your digital currency information on your return, but also help you with your return in general to ensure that every section of is completed correctly.
Contact Us Today
If you have traded, purchased, or sold cryptocurrency and are not sure how to include it on your income tax return, or have other tax-related questions about cryptocurrency, then reach out to the tax advisors at Enterprise Consultants Group. We can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.
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