Common assumption on tax reporting and filing about crypto

Over the years, IRS has sent letters in different versions to people with digital currency transactions who may have failed to report income and pay tax or who did not report their transactions properly.

Of course, no one wants to receive a letter from the IRS. However, If you get an IRS letter, don't ignore it. Correct all the error that is asked from the IRS letter, and consider making corrective filings for a number of past years and paying taxes without being asked. The IRS is generally considerably more forgiving if a taxpayer makes corrective filings before being audited or investigated.

More likely, cryptocurrency is an ongoing focus area for IRS criminal investigation. In this article, we are going to discuss some common assumptions about cryptocurrency tax reporting and filing.

Assumption#1

You won’t owe any tax on cryptocurrency transactions unless you receive an IRS Form 1099. Since you did not receive a Form 1099, you check the box on your tax return that says that you did not have any transactions with cryptocurrency.

Fact: You may still owe tax even if the payor or broker does not file a form 1099. However, a form 1099 does not create tax where no tax was previously due, and plenty of taxable income is not reported on form 1099. Therefore, you need to calculate the cost basis of your crypto trading transaction to find out the gain/loss.

You can click here to learn how to calculate the gain/loss of your cryptocurrency trading.

Assumption#2

If you hold your cryptocurrency through a trust, LLC, or other entity, then you do not owe tax on the crypto transactions and do not have to report them.

Fact: It is true that owning crypto through an entity may keep the income off from your personal tax return, but the entity itself will likely have tax reporting obligations and may owe taxes. For example, if a multiple-member LLC has income from crypto trading, the income will pass through to the members, and each member is going to report the income and pay tax accordingly. Single-member LLC is disregarded, so the LLC income ends up on the sole owner’s return.

In an extreme case, If your entity is a foreign entity, there are complex U.S. tax rules that can make you directly liable for certain income produced within the foreign entity.

Assumption#3

Instead of selling, what if you transfer your crypto as a loan to someone else, then you do not need to report the proceeds?

Fact: It will depend on 2 factors. Are you getting the same crypto back that you are loaning? Are you charging interest on the loan? If you are getting the same crypto back without including any interest or additional service fee, it will be a tax-free event. If you charge interest on the loan, you will only need to pay tax based on the interest income that you received.

Assumption#4

The IRS treats cryptocurrency as a type of property. Section 1031 like-kind exchanges will likely apply in this case to make crypto-to-crypto exchanges non-taxable.

Fact: In any case, now that Section 1031 has limited like-kind exchange treatment to real property, crypto-to-crypto swaps are taxable unless they qualify for another exception.

This article is for general information purposes and is not intended to be and should not be taken as legal advice. If you are interested in finding out more about how crypto taxation works, please contact us with the crypto taxation consultation. We at SBS Tax and Consulting Services have built cryptocurrency tax software that allows you to easily generate tax reports using the accounting method of your choice.