18 Sep 23

The Most Common Cryptocurrency Tax Reporting Mistakes to Avoid an Audit

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Last Updated on: 19th September 2023, 12:52 am

Avoiding Cryptocurrency Tax Audit Triggers

Cryptocurrencies like Bitcoin and Ethereum offer exciting new possibilities, but they also come with tax reporting requirements that can trip up unsuspecting users. This article provides tips on avoiding common crypto tax mistakes that may increase your risk of being audited by the IRS.

Failing to Report Crypto Transactions

Some cryptocurrency owners believe that if they simply don’t report their crypto activity, the IRS won’t find out. This assumption is completely false. The IRS has advanced tools to identify unreported virtual currency transactions. Not reporting any taxable crypto activity can lead to audits, penalties, and even criminal charges in extreme cases.To stay compliant, you must report all crypto transactions, including trading cryptocurrency for cashexchanging one crypto for anotherearning crypto as incomespending crypto on goods or services, and gifting crypto to someone. Failing to report any taxable crypto activity significantly raises your risk of being audited, so it’s critical to disclose all transactions accurately.

Not Maintaining Adequate Records

Meticulous record keeping is essential for calculating crypto gains, losses, and income correctly. The IRS requires taxpayers to keep records that sufficiently document figures reported on tax returns. Without organized documentation, you may have difficulty substantiating your tax calculations if audited.Be sure to maintain records of:

  • When you acquired cryptocurrency and its fair market value at that time
  • When you sold or traded cryptocurrency and its fair market value at that time
  • The purpose of each transaction (investing, trading, purchasing goods, etc.)
  • Which accounts you use (exchanges, wallets, DeFi platforms)

The easiest way to track this information is with a cryptocurrency tax software. They can sync transaction data from exchanges and wallets to eliminate manual work.

Not Reporting Cryptocurrency Received as Income

Some cryptocurrency holders believe they only need to report capital gains and losses from trading. In reality, you must also report crypto received as income. Common taxable crypto income sources include:

  • Mining rewards
  • Staking yields
  • Airdrops
  • Interest
  • Cashbacks/rebates
  • Referral bonuses
  • Bounties
  • Hard forks

When you receive cryptocurrency as income, you must report the fair market value at the time of receipt. Failing to report crypto income constitutes illegal tax evasion and may warrant criminal charges if discovered in an audit.

Incorrect Cost Basis Tracking

Cost basis refers to the original value of cryptocurrency when acquired. It is essential for accurately calculating capital gains and losses. If you don’t properly track cost basis, your taxable gains and losses will be incorrect. Common errors include:

  • Using the wrong cost basis method (FIFO, LIFO, etc.)
  • Forgetting cost basis from old crypto purchases
  • Not adjusting basis for chain splits
  • Not tracking inherited crypto basis

Cryptocurrency tax calculators can eliminate guesswork by automatically tracking cost basis across all your wallets and transactions. Don’t risk mistakes by manually calculating basis.

Misreporting Cryptocurrency Trades

Some traders believe exchanging one cryptocurrency for another is a tax-free “like-kind exchange.” However, this only applies to real estate after the 2018 tax reform. Now, trading one crypto for another triggers a taxable event. You must report:

  • Capital gain/loss from selling the original crypto
  • Fair market value of the new crypto received

Failing to report crypto-to-crypto trades is a red flag for IRS auditors. Make sure to accurately calculate and report taxable gains from every trade.

Forgetting to Report Cryptocurrency Gifts and Tips

Giving cryptocurrency as a gift or tip is a taxable event. Many taxpayers forget or don’t realize they must report these transactions. When you gift crypto, you must calculate and report capital gains based on your cost basis and the fair market value on the day you gave the gift. The gift recipient also inherits your cost basis.For small crypto tips under $10, you may not have to report capital gains. But tips over $10 must be reported like other gifts.

Not Reporting Crypto Mining or Staking Income

As mentioned earlier, crypto mining and staking rewards are considered taxable income. You must report the fair market value of rewards on the day they were received. These periodic yields are taxed as ordinary income, so you don’t have to wait until you sell to owe taxes. Keep detailed records of all mining and staking payouts as they occur.

Overlooking FBAR and FATCA Reporting

Owning cryptocurrency does not exempt you from reporting foreign financial assets. U.S. citizens with foreign crypto exchanges, wallets, or accounts exceeding $10,000 must file FBAR and FATCA forms. Willful failures to disclose can warrant severe penalties. With proper reporting and documentation, you can avoid common cryptocurrency tax mistakes that may increase audit risk. Consider using tax compliance software and consulting a crypto tax professional to ensure accurate filing. The IRS is cracking down on noncompliance, so take reporting seriously.