It is that time of the year again. Ben Franklin’s inevitability. Taxes.
For many, taxes are a time of celebration because each year they get tax credits and refunds from the Government. For others, it is a time of panic and scrambling to gather the information to call it good riddance for the year.
Individuals with filling crypto tax return matters, well, they are a different ball game.
Gathering the information to report all crypto transactions is a nightmare, and that’s underselling the pain.
While using a crypto tax software is ideal, not everyone wants to use them and for some, they may have kept a good track of all their crypto tax transactions and don’t have a need to use the software.
Whether you use filling crypto tax software or do it yourself, there are few things that you may have not thought about. We are going to look at the top 5 best practices to report crypto tax transactions.
Best Practice 1: Reporting Income from Foreign Sources (yes, including foreign exchanges)
If the current trend is any indication, tax authorities and Governments of many countries are coming together to ensure that Crypto does not become an avenue for money laundering and tax evasion. To this end, they are forcing the crypto exchanges to report the transaction information with the tax agencies.
We all know about the IRS summons to Coinbase.
Point is, if you are thinking that your transactions in the foreign exchanges are in safe hiding, you may be wrong.
In the US, the IRS has taken a kinder stance with individuals that show good faith in reporting every transaction. However, a willful concealment never finds a good justification.
We cannot tell you whether you should report it or not. The Law does. It is up to you whether you want to follow the law of your land or not, as long as you are prepared to face the consequences.
Best Practice 2: Treatment of bankrupt coins due to Crypto exchange hacking or Government action
Some opine that you can claim these coins as a total capital loss. That means their value is now zero. You can even carry forward these losses and put against future gains.
Make sure you keep good records because you may be asked to justify that this decision. So if the token went to zero, is defunct, you sent to an address and they disappeared, you got scammed, you lost your keys – then you can consider taking a capital loss on those coins.
Claiming that you cannot access your funds because of lost keys could be tricky to prove. However, an exchange hack or SEC action that results in loss can be justified as the news is generally in public domain, as long as you have good records of all the purchases you made in those particular coins and/or exchanges.
If the cryptocurrency you hold has the same status as securities in the eyes of law, then the treatment of worthless stock (US) may be an option. Talk to your tax attorney or CPA to see what works for your situation.
In a recent interview, Aaron Grinhaus, an Attorney practicing in Blockchain and Crypto space opined “From a tax perspective this depends on whether the tokens were purchased in the course of business or for personal use. If it was in the course of business it could be construed as a business loss, either capital or current depending on the characterization of the assets. If it was for personal use what is less clear what tax benefit may be available.”
Best Practice 3: Income from Airdrops and Mining endeavors
If you operate a mining company, you are in the business of making money. As such, you should report the transactions related to your business on your tax returns as you would any other business venture.
You get to deduct your expenses like electricity costs, rent, depreciation on the mining machines, etc. to arrive at the compensation that needs to be reported to the tax authorities.
Whether you dispose of the coins received through mining or airdrops is not relevant, the date of receipt will be when you recognize your income at market value for tax purposes.
Note: Whether mining is legal in your place of residence is an aspect you need to look into, which is beyond the scope of this article.
Pat Larsen, CEO at Crypto Tax Software company ZenLedger, reminds us that “any coins that you earn as a miner while processing transactions are considered income by the US government and treated as such. Then, if you hold onto the mining reward and later sell it at a gain, there is a capital gains component as well. So at time or mining reward, the coin you received is considered income at the market price of the coin. If you hold the coin for a period of time and sell it later for a profit, that profit will be taxed as a capital gain.”
Best Practice 4: Don’t forget the FinCEN (FBAR) and FATCA reporting
Cryptocurrency transactions pose yet another added obligation for Americans (your country may have something similar, our friends tell us that India and the United Kingdom have similar reporting).
Any financial assets, including Cryptocurrency, held outside the US will have to be reported to two agencies once the specific threshold is met, i) United States Treasury; ii) Internal Revenue Service:
- FinCEN Form 114: this is a disclosure filed with the United States Treasury whenever aggregate of your foreign financial accounts reaches $10,000. Remember, for the purposes of $10,000, you have to add balances in all the accounts, once the threshold is met, every foreign financial account has to be disclosed. Our FREE guide goes into greater detail.
- FATCA: If you don’t know what FATCA is, probably, you should talk to a tax professional. One of the inadvertent consequence of having crypto transaction is that it could trigger FATCA reporting. While the reporting thresholds are higher than FBAR, you want to make sure you are compliant with FATCA regulations.
The penalties for not disclosing overseas holding are different from the IRS penalties for not paying taxes. Government agencies are constantly trying to monitor the flow of cryptocurrency that may be trying to get around sanctions or get too bad actors around the world. The IRS focused heavily on revealing Swiss bank accounts and they are looking closely at crypto now too.
Jason Bierly from Aprio conveys that while there is “no formal regulatory / tax guidance as it relates to cryptocurrency. We are interpreting current legislation to apply the US$10,000 threshold across all foreign exchanges for FBARs.
Non-willful violations come with a potential penalty for not filing is $10,000. The willful neglect penalty is greater of $100,000 or 50% of the amount in the account for each violation.
Filing Form 8938 does not relieve you of the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Failure to file Form 8938 comes with a $10,000 penalty.”
Best Practice 5: Choosing the right Tax Method to use
While filling crypto tax software like Cointracking provide multiple methods to use, not all of these methods are accepted in every country. You need to first check which method you want to use and if you can consistently keep using that method.
- First In First Out (FIFO): This method reports transactions as though the crypto you bought at the beginning is sold first. Depending on when you bought your crypto – this may result in a higher or lower tax. This is the most widely used and generally used method.
- Last In First Out (LIFO): As the name suggests, you are assumed to have sold the most recently bought crypto first. You have to make sure that if you choose to use this method – you are using it consistently. You cannot jump between methods.
Andrew Gordon, CPA, and ZenLedger legal advisor remind investors that “while the IRS has not explicitly spelled out which tax method to use, he strongly recommends the FIFO option, like your least risky approach. The main requirement of selecting LIFO accounting is the ability to individually identify a coin or fraction of a coin down to 8 digits. This seems like a very tough task.”
Honesty really is the best way to go when it comes to taxes and disclosures.
If you are looking for Crypto tax software review, you can see our earlier article: Comparing the BEST Crypto Tax Software
Thank you for reading this article.
Everything in this article is an opinion, not an advice of any kind. This material has been prepared for general informational purposes only and it is not intended to be relied upon as accounting, tax, investment, legal or other professional advice. Please consult with a professional for specific advice.
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About the author
RK Reddy holds two Masters degrees, one in Accounting and another in Business Administration with over 15 years of experience in the financial services industry.
RK Reddy is an ardent fan of Blockchain and Cryptocurrencies. You can see the excitement about this new technology in every article on Cryptotapas.com. Sometimes this excitement leads to an overly optimistic view. Guilty as charged. RK Reddy says “what may seem like an ‘overly optimistic expectation’ today may become an everyday norm in 5-10 years; look at the history of cars or airplanes, Blockchain and Cryptocurrencies belong to a similar frame of reference.” Of course, that is just his opinion.