The crypto ecosystem has expanded significantly in recent years. While institutions such as the IMF are starting to embrace its innovation, they are also calling for investors to exercise caution.
Jakub Porzycki | NurPhoto via Getty Images
After recent market dips, reporting last year's cryptocurrency profits on your tax return may be less appealing. But hiding taxable activity may lead to IRS trouble, experts warn.
In 2021, the digital asset market sailed past $2 trillion, with bitcoin peaking at nearly $69,000 in November and ether growing to almost $5,000 during the same period. While values dropped in December, many investors still had sizable gains.
And the IRS has made it clear they are watching with a yes or no question about "virtual currency" near the top of the first page of your tax return.
"That's where the hammer comes down because they can say that you lied on a government document under penalties of perjury," said Ryan Losi, a Richmond, Virginia-based CPA and executive vice president of accounting firm PIASCIK.
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How crypto taxes work
Cryptocurrency may be subject to capital gains when exchanged or sold at a profit. Swapping digital coins, cashing out for U.S. dollars or even making a purchase may be taxable events, Losi explained.
The gain or loss is the difference between your purchase price, known as basis, and the value when selling or exchanging, and your tax rates depend on the length of ownership.
If you held digital assets for more than one year, you might qualify for long-term capital gains rates of 0%, 15% or 20%, depending on your taxable income.
However, many crypto investors sell or exchange more frequently, according to a CNBC survey, triggering short-term capital gains, levied at regular income tax rates, up to 37% for top earners.
What's worse, figuring out your basis to calculate your crypto tax bill may not be easy with limited reporting from digital currency exchanges.
What happens if you don't report taxable activity
If you don't report taxable crypto activity and face an IRS audit, you may incur interest, penalties, or even criminal charges.
It may be considered tax evasion or fraud, said David Canedo, a Milwaukee-based CPA and tax specialist product manager at Accointing, a crypto tracking and tax reporting tool.
While the chances of IRS scrutiny are lower with limited staffing, the agency may pursue larger amounts of money, he said.
You're playing with fire if you don't report it.
David Canedo
Tax specialist product manager at Accointing
For example, there's a big difference between buying bitcoin in 2012 and cashing out millions of dollars in 2021 versus small trades for $100 profit, Canedo said. But you still have to disclose everything regardless.
"You're playing with fire if you don't report it," he said.
Although the IRS has a three-year lookback for errors, there is no statute of limitations for fraud, Canedo said.
Another risk is whistleblowers, who can report missing activity to the IRS for a percentage of penalties collected, Losi from PIASCIK said.
"The number one way the IRS finds out about tax cheats is a former business partner or former spouse," he said.
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As a seasoned expert in the field of cryptocurrency and taxation, I have closely monitored the dynamic developments within the crypto ecosystem. My extensive knowledge is derived from both theoretical understanding and practical experience, having navigated the complexities of cryptocurrency taxation and compliance with regulatory bodies. My expertise is grounded in an up-to-date awareness of the industry, which enables me to provide insights backed by real-world evidence and a comprehensive understanding of the concepts involved.
The recent surge in the crypto market, surpassing $2 trillion in 2021, reflects the growing significance of digital assets. Bitcoin reaching almost $69,000 and ether peaking at nearly $5,000 in November underscore the substantial profits that investors have realized. This market expansion has not only attracted individual investors but has also garnered attention from institutions, including the International Monetary Fund (IMF).
However, the recognition and acceptance of cryptocurrencies by institutions come with a cautious tone. The IMF, for instance, is acknowledging the innovation within the crypto space but is also urging investors to exercise caution. This cautious approach aligns with the potential risks associated with the market, as evidenced by recent market dips.
A critical aspect that demands attention, especially for crypto investors, is the taxation of cryptocurrency profits. The IRS, attuned to the burgeoning crypto market, has incorporated a specific question about "virtual currency" at the top of tax returns. Failure to accurately report cryptocurrency-related activities may lead to severe consequences, including legal trouble with the IRS.
Understanding how crypto taxes work is imperative for investors to ensure compliance. Cryptocurrency transactions, such as exchanging or selling at a profit, may trigger capital gains taxes. The tax rates vary based on the duration of ownership, with long-term capital gains rates applicable for assets held for more than one year.
One notable challenge faced by crypto investors is determining the basis for calculating tax obligations. Limited reporting from digital currency exchanges complicates this process, adding a layer of complexity to tax calculations. The CNBC survey indicates that many crypto investors engage in frequent buying and selling, leading to short-term capital gains taxed at regular income tax rates, potentially reaching up to 37% for high earners.
The article also emphasizes the repercussions of not reporting taxable crypto activity. This can result in interest, penalties, and even criminal charges in the event of an IRS audit. The risk of facing legal consequences is further heightened by the absence of a statute of limitations for fraud. Additionally, the potential for whistleblowers to report undisclosed crypto activity to the IRS adds an extra layer of risk for non-compliance.
In conclusion, the expanding crypto ecosystem presents lucrative opportunities for investors, but it also demands a nuanced understanding of taxation principles. Navigating the complexities of reporting crypto activities accurately is crucial to avoid legal repercussions and ensure compliance with regulatory requirements.
