How are cryptocurrency taxes reported?

Over the last year, the government has taken note of the increase in cryptocurrency investments, issuing formal communications of their regulation efforts.

Recognizing the growth in cryptocurrency transactions has led many government organizations to crack down on investors over the past year.

According to the White House and Democratic legislators, the crypto economy and previously lax reporting requirements are largely responsible for the recent tax gap.

Earlier this year, several fiscal government organizations have sent letters communicating the importance of tax reporting and requesting information on the data stored by a cryptocurrency exchange.

The push for more regulation is now becoming evident in the requirement of answering "yes" or "no" to a tax form question about cryptocurrency transactions throughout the year. Failure to disclose this information and associated income might result in significant penalties for the investor.

Investors must calculate their net gain or net loss before choosing their filing status, deciding how they will file their taxes, determining if they are taking the standard deduction and making a payment if it is owed.

To file their taxes, users may start calculating their gains and losses manually or by consulting a tax-planning professional. Capital gains and losses incurred by an individual investor require completing IRS Form 8949. The total gains and losses are combined, arriving at either a net capital gain or a net capital loss. This amount is then added to an investor's total income from the rest of their investments, such as stocks, into form 1099-B. A tax professional, CPA or software filing solution will use the information provided on this form to generate Form 8949. 

In most cases, exchanges will report 1099-B Forms for cryptocurrency trading transactions, which investors can match with Form 8949. Issues only arise when there are discrepancies in values, resulting in audits or a CP2000 notice.

With the completion of these calculations, investors may undergo the rest of the standard steps involved in filing their taxes. These steps include determining the filing method (the IRS typically recommends tax preparation software to e-file), deciding between a standard deduction or itemized return and making a payment if it is applicable.

Cryptocurrencies are treated differently than standard assets, which, when combined with the limited CPA resources with extensive knowledge on cryptocurrency taxation, result in a stressful tax season.

The current framework is complex to navigate since the IRS treats cryptocurrencies like Bitcoin (BTC) and nonfungible tokens (NFTs) differently from other assets, classifying them as property. Since different rules apply, investors often require the help of a professional or proper crypto tax software to record this activity correctly.

Other rules add complexity to the management process by suggesting that the use of fiat currency (dollars) to purchase assets in 2021 doesn't require an indication on a tax report at the time of writing.

But, selling or exchanging the same virtual currencies does require a report. Therefore, for those doing a lot of trading or holding many different currencies, the sheer number of data that must be navigated through can add to the complexity.

While in previous years, leveraging a tax professional has been an option to help with some of the more complex nuances associated with tax management, the last year has been marked by a great resignation of tax professionals. With more reports of burnout and overtime hours caused by the COVID-19 pandemic, investors are often left on their own when it comes time to calculate taxes accrued.

Investors can look to several optimization strategies, including the 0% tax rate for long-term gains and HIFO methods.

Investors can take advantage of several opportunities to optimize tax returns, including the 0% long-term capital gains tax rate. The U.S. tax code also has a relatively lesser-known 0% tax rate for certain long-term gains.

Depending on an investor's filing status, annual income and length of time a digital asset has been sold, up to $80,000 in profits can be made without being subjected to taxes.

Another strategy is known as the highest-in-first-out method for specific identification. This method is more taxing, requiring users to select the asset purchased at the highest price. Users can then classify these units as the items being sold, resulting in the lowest amount of gains and, therefore, lower tax bill.

Take netted losses against profits earned through cryptocurrency to bolster an investor's tax return.

To offset some of the taxes incurred through investing, many will leverage a strategy known as tax-loss harvesting. With harvest losses, investors look for dips at cryptocurrency prices for when the sale of digital assets falls below cost basis. These losses can be netted against capital gains to reduce an investor's overall tax bill.

Specialized cryptocurrency tax software enables users to generate a crypto tax report for their country, oftentimes generating Form 8949 alongside other files for e-file submission or to provide to one’s CPA.

To make an investor’s life or the life of a CPA easier, investors who engage in cryptocurrency trading can start by gathering all of their crypto transaction reports throughout the year. Modern crypto tax software tools such as Accointing automate this process to reduce the time spent compiling these documents.

The Accointing platform incorporates over 400 integrations, many of which are notable cryptocurrency exchanges, into a single view on a mobile app or desktop. With a cohesive set of data, users can calculate their total wins and losses for the year, providing the basis for a customized tax report for a CPA in a few minutes.