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Digital assets are certainly on the rise and will continue to grow as technology advances. The ambiguity, novelty, and lack of IRS guidelines make cryptocurrency accounting and auditing extremely challenging. Cryptocurrency users are seeing an increase in resources and software that can help them accurately report their digital assets to the IRS.
Those who choose not to report taxable crypto activity can be audited by the IRS and may face penalties, interest charges, and even criminal investigations. As cryptocurrency continues to gain public acceptance, the Public Company Accounting Oversight Board (PCAOB) is creating informational guides that serve public accounting firms to help their clients stay compliant with the IRS.
Audit Considerations Related to Cryptocurrency
Cryptocurrency has created a great challenge for tax compliance with the IRS, which is now focusing on auditing the income received from this new trading technology. Since cryptocurrency is still in its infancy, the IRS has a limited understanding of all tax implications. Cryptocurrency Accounting in Bakersfield, CA brings together a team of tax lawyers who can help individuals in all accounting and reporting matters for cryptocurrency users.
Tax auditors barely have enough experience to deal with cryptocurrencies and the IRS provides little guidance in this matter. In addition, cryptocurrency records lack comprehensive information which poses a greater challenge during audits.
Common Cryptocurrency Compliance Issues
According to reports from CNBC, in 2021, the U.S. Treasury Department announced that it is cracking down on cryptocurrency transactions and markets requiring transfers of $10,000 or more to be reported to the IRS. Furthermore, they mentioned that the cryptocurrency market creates a great detection issue by making it easy for investors to engage in illegal activities including tax evasion.
Banks are creating compliance teams centered on cryptocurrency compliance programs that have become part of the daily activities of financial institutions. Below are three main compliance issues to consider.
Phantom Like-Kind Exchange
A common issue is when the cryptocurrency investor uses a phantom like-kind exchange to defer or postpone capital gains. The person replaces one asset with another of similar nature, class, or character. It is a strategy frequently used in real estate transactions. Although the IRS provides instructions on how to report cryptocurrencies in “like-kind” exchanges, many people still do not fulfill reporting requirements on Form 8824.
Failed to Report Foreign Exchange Accounts
The IRS requires all U.S. citizens and residents, including entities, to file Form 114, Report of Foreign Bank and Financial Accounts (FBAR). It applies to those who hold foreign financial accounts with an aggregate value of over $10,000 during a calendar year.
FBAR reporting applies whether or not the filer received taxable income from the foreign account. There are strict penalties that are enforced for non-compliant individuals and entities.
Airdrop, Fork Income
Another effort by the IRS to regulate crypto assets is to tax airdrops and forks income. Starting in 2019, the IRS determined that airdrops and fork income are taxable and recipients of these assets should treat newly received cryptocurrency the same as ordinary income regardless of the control the taxpayer has over the fork and airdrop. The IRS addresses virtual currency non-compliance with audits and criminal investigations to penalize those who do not report this income.
Cryptocurrency Bookkeeping: How is it Different?
Most cryptocurrency is traded on various platforms that have their own documentation standards. This poses a problem to CPAs who need to gather accurate information on cryptocurrency gains and losses to present to the IRS. Cryptocurrency bookkeeping is different because it deals with daily transactions that are hard to record and there are no general guidelines in place that individuals or businesses can follow. The nature of cryptocurrency transactions creates a major bookkeeping challenge as accountants try to report all transactions in a compliant manner.
How to Calculate the Basis in Cryptocurrency
The basis must be accurately calculated to determine the capital gains and losses. To calculate the basis of cryptocurrency, the price acquired or purchase price must be added to the purchase fees.
How Do You Calculate Capital Gains on Cryptocurrency?
Once you calculate the basis, you must subtract it from the proceeds to calculate the capital gains or losses. The capital gains or losses are the difference in crypto value from when it was acquired to when it was disposed of. The IRS expects investors to report both the gains and losses.
What is Considered a Taxable Event When Dealing With Cryptocurrency?
Generally, the IRS wants to collect taxes on crypto that has increased in value from when it was initially purchased. Various types of taxable events for cryptocurrency include selling cryptocurrency for a fiat currency, using it to buy goods and services, and trading it for other types of cryptocurrency.
Income from crypto is also taxed in the case of receiving crypto as a form of payment, earning rewards from mining and staking, and receiving interest payments from lending cryptocurrency.
What Happens When You Lose Money on Cryptocurrency?
Capital losses on cryptocurrency can be deducted similar to how it works with stocks and bonds. The losses help to offset capital gains on sales. The IRS allows write-offs on a loss over $3,000.
So Where Do I Report my Gains or Losses?
The IRS requires cryptocurrency gains or losses to be reported on Schedule D and Form 8949 as it is considered property. Schedule D shows the basis that is subtracted from total proceeds, which will determine the capital gain or loss and how much taxes are owed along with the deductions received.
What are Realized Gains and Losses?
A realized loss or profit happens when cryptocurrency investors sell their digital assets. The realized gain or loss is calculated by taking the difference between the cost and the money received from the sale of crypto. A realized gain applies when the proceeds are greater than the basis. A realized loss happens when the proceeds are less than the basis.
When I trade Cryptocurrency on an Exchange, I pay Commissions and Fees. How Do I Treat Those Costs?
Before the Tax Cuts and Jobs Act (TCJA), it was possible to deduct investment-related expenses such as cryptocurrency commissions and fees. However, the IRS has eliminated these deductions for tax years 2018 to 2025. To save money on transaction fees, investors adjust their basis on the purchase and by deducting fees from sale proceeds when disposing of crypto.
Classification of Cryptocurrency Holdings in Bakersfield, CA
Cryptocurrency is classified into three major types according to their utility:
- Currency: The first type of cryptocurrency was bitcoin, designed to be used as payment for transactions on any public decentralized blockchain.
- Asset: Stablecoins is a type of cryptocurrency that gets its value from external assets. For instance, USDT gets its value from the U.S. dollar and Gold GLC from gold.
- Object: This type of cryptocurrency was designed for financing special projects such as the creation of Siacoin (SIA) for dealing with expensive cloud storage. This type of currency leverages blockchain technology to provide an affordable data storage marketplace compared to traditional cloud storage providers.
Accounting for Cryptocurrencies in Bakersfield, CA
Knowledgable cryptocurrency CPAs require a special type of knowledge and network to provide support to investors during tax season. The proper disbursing or receiving payments of digital assets utilizes a specific approach to valuing digital asset holdings, ongoing accounting, and transactions.
Major cryptocurrency accounting platforms are used with specialized accounting software to manage digital assets and stay compliant with the IRS.
Frequently Asked Questions
What are intangible assets?
According to the International Financial Reporting Standards (IFRS), intangible assets are considered to be a non-monetary asset without physical substance. Examples are franchises, trademarks, copyright, films, patents, licenses, software, and others. Intangible assets are very challenging to valuate.
What are crypto assets?
The Financial and Consumer Services Commission defines crypto assets as purely digital assets that prove ownership by using internet-based public ledgers such as blockchain. Crypto assets may be used as a form of exchange for transactions, as a way to store and appreciate value, and for various financial business purposes. They usually operate independently of a central authority, government, or financial institution.
Can cryptocurrency be audited?
Yes, cryptocurrency can certainly be audited by the IRS. Investors will be required to have a detailed report of their crypto trading history for the tax years being observed. The auditor’s main goal is to determine if the cryptocurrency investor has reported their digital assets correctly on their tax returns. The conclusion of the audit will provide information about taxes owed and if the investor will incur penalties or other sanctions.
How do auditors audit cryptocurrency?
The first step auditors take when evaluating digital assets is to assess the actual blockchain protocol being used. This will help them analyze the evidence in question. The auditor also considers the various types of cryptocurrencies being traded and how the transactions were performed. Some transactions are executed automatically with the use of a smart contract while others are manually initiated.
Auditors are faced with the challenge to verify the existence of digital assets. They are able to use auditing tools that assist them in understanding the individual or business being audited. By following the guidance of International Financial Reporting Standards, auditors are able to accurately assess tax implications for cryptocurrency users.
What are audits in crypto?
Audits in crypto are assessments that determine if the recorded transactions in a particular blockchain ledger are correct and verifiably complete. This practice prevents criminal activity within the digital assets community including tax evasion and money laundering. Cryptocurrency users are now beginning to become aware of the importance of having the right tools that will help them to accurately record transactions and properly report their digital assets to the IRS.
How do you account for cryptocurrency in accounting?
In accounting practices, receipts of cryptocurrency are placed under revenue recognition rules for digital assets. When cryptocurrency is used to pay for company expenses, the sale of the digital currency along with the receipt of the expense paid is considered a non-cash item.
All cryptocurrency trading activities must be recorded similarly to stocks. Cryptocurrency purchased with a fiat currency should be recorded by crediting the entity’s cash account and debiting a newly created crypto-asset account.
What if I invest in cryptocurrency outside of the United States? I know that I have to report brokerage accounts and other assets on an FBAR. Does that apply here?
The IRS currently does not have clear guidelines for reporting foreign accounts on FBAR. Although the U.S. government has provided some guidance, they have no concrete rules that taxpayers can follow to comply with the reporting of offshore accounts. Accountants recommend cryptocurrency users report all foreign accounts that may be required on an FBAR to avoid harsh IRS penalties.
Since I don’t have to report it on an FBAR, what happens if I just don’t report it all, anywhere?
It is very risky to not report accounts to the IRS. In the case the IRS determines that the cryptocurrency user committed a violation, the person or business can face penalties of 50% of the value of the account or $100,000, whichever is the highest amount. As CPAs are becoming more knowledgeable about how to properly report digital assets, it is best practice to report all “reportable” accounts to the IRS.
Professional Help with Tax Issues
Are you looking for a reputable, local company to handle all your crypto tax issues? The experienced financial professionals at The Tax Crisis Institute have been helping Nevada and California residents with state and federal tax issues since 1983, and they are committed to making sure that their clients do not pay the government any more than they have to. If you need help with a tax matter, you can fill out our online form or call one of our offices. We have locations in Orange County, Bakersfield, Los Angeles and Las Vegas.
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