5 Important Facts About Income Taxes for Cryptocurrency Investors

It’s that time of year again when cryptocurrency investors need to review their transaction histories so that they can prepare their tax returns. While the IRS has extended Tax Day to May 17, 2021, for individuals, that date is just over the horizon, and investors need to make sure they have all of the information they need in order to accurately file their returns on time. Are you a cryptocurrency investor? Does your company use cryptocurrency to transact business? If so, here are five important facts from New Jersey tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group:

1. The IRS is Paying Attention in 2021

The IRS is paying particular attention to cryptocurrency investors and companies that use cryptocurrency in 2021. After sending several rounds of “education letters,” the IRS is now preparing to vigorously enforce taxpayers' obligations with regard to cryptocurrency after Tax Day. If you owned cryptocurrency in 2020, you owe reporting obligations to the IRS. Not only that, but the IRS may already know about your holdings from your cryptocurrency exchange.

2. Cryptocurrency Investors Must Report Their Gains and Losses

Under the Internal Revenue Code, cryptocurrency investors must accurately report their gains and losses. This includes both ordinary and capital income, and it includes gains and losses from both short-term and long-term investments. Even if a cryptocurrency transaction does not trigger federal income tax liability, the transaction still needs to be reported—and failure to report it can still lead to an audit or prosecution for federal tax fraud.

3. Different Transactions Can Have Different Tax Consequences

Not all cryptocurrency transactions are alike for federal income tax purposes. For example, while the “cost basis” for purchased cryptocurrency may be the purchase price, in other circumstances basis may need to be determined based on fair market value (FMV) at the time of the transaction. Additionally, while most cryptocurrency transfers are capital transactions, cryptocurrency received in exchange for services or as the result of an airdrop following a hard fork may qualify as ordinary income.

4. Substantiation is Key

When reporting cryptocurrency transactions to the IRS, substantiation is key. Individual and corporate taxpayers need to have documentation that supports their tax filings, and they must be prepared to provide this documentation to the IRS if necessary.

5. Questionable Filings are Likely to Trigger Cryptocurrency Tax Audits

Given the IRS’s focus on cryptocurrency in 2021, questionable filings are likely to trigger cryptocurrency tax audits. This includes filings that contain miscalculations as well as filings that entirely omit transactions reported to the IRS by taxpayers’ cryptocurrency exchanges. Facing an IRS audit or investigation is a serious matter, and mitigating any potential penalties requires a careful approach and strategic legal representation.

Questions? Contact New Jersey Tax Attorney Kevin E. Thorn, Managing Partner of Thorn Law Group

Do you have questions about your (or your company’s) federal cryptocurrency tax obligations? If so, we encourage you to get in touch. To request a confidential consultation with New Jersey tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, call 201-355-8202, email ket@thornlawgroup.com or contact us online today.