Three Common Crypto Tax Pitfalls To Avoid

Filing crypto taxes is not an option; its’ required by the tax law. If you are still under the impression that the IRS has no visibility into your crypto activity, read “How the IRS Knows You Owe Crypto Taxes” post. Whether you are a self filer or using a professional to file your taxes, this post discusses 3 common crypto tax pitfalls you can easily avoid to stay out of the IRS radar.

Not Reporting Anything At All

Although it is very clear that US taxpayers have to pay taxes on cryptocurrency related transactions like sales, crypto to crypto trades, mining, etc, some taxpayers still choose not to report anything at all. This is mainly due to a couple of reasons. First, many people believe that the IRS has no way of finding out their cryptocurrency related activity. However, this is not the case. The IRS can find out about your crypto activity through 1099 reports, subpoenas and Schedule 1.

Second, hardcore crypto enthusiasts believe that taxes mandated by a centralized agency is not compatible with the ethos of the crypto world, which relies heavily on the concept of decentralization. Although there is some validity for this argument, until we get to a purely decentralized world, taxes the way it’s enforced today is essential to maintain the economy. Thus, proper reporting and paying your fair share of taxes is important.

If you do not report anything, you could be subject to several penalties such as late payment, late filing & failure to file. Avoid reporting nothing; at least report something which is better than reporting nothing.

Reporting Only Losses Or Tax Friendly Transactions

Taxpayers love claiming as much as write-offs, deductions, credits & losses as possible  because they reduce the tax bill. Notably, in many cases, these items are more scrutinized by the IRS than under reported or omitted income.

It is common to see that some crypto holders report big losses during bear markets and avoid reporting gains completely or partially reporting them during bull markets. This is not advisable because the IRS may flag these trends and penalize you for incorrect reporting. Similarly, if a mining operation keeps having tax losses year after year without making any profit, the IRS could argue that it is not a trade or business and disallow all the deductions. As a result, you can end up paying thousands of dollars of back taxes.

The point here is that, do not overstate your crypto losses or related deductions. IRS agents are well trained to catch numbers and tax events that do not seem reasonable compared to industry trends and your past return data.

Poor To No Record Keeping

Good record keeping is crucial to support the amounts reported on your tax return. The duration you should keep your crypto transaction history files depends on several factors. In general, it is best practice to keep the records for 3 years.

With that said, note that, you must:

  1. Keep records indefinitely if you do not file a return.
  2. Keep records indefinitely if you file a fraudulent return
  3. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.

Losing records due to exchange closures and not keeping any records at all are very common among crypto taxpayers. A good practice is to use a reputed crypto tax software, not only to calculate your crypto capital gains & losses, but also to make sure that all your source data is in one place, when/if needed. Keep in mind that whether you use an accountant or a self-service tax software for crypto tax reporting, in most cases, the ultimate burden of proving the amounts reported on the forms is with you.

Overall, the above practices will easily help you stay out of the IRS radar and make you well prepared in case your return is selected for an audit.

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