Cryptocurrency has become increasingly popular recently, with millions worldwide investing in digital assets. However, as the popularity of crypto grows, so does the need for proper accounting practices, which is where a crypto accountant comes in.
This comprehensive guide will dive into the role of a crypto accountant, the importance of accounting for cryptocurrency, and how the IRS views cryptocurrency.
Whether you are an individual investor or a business involved in crypto, understanding crypto accounting is crucial for maintaining compliance and making informed financial decisions.
A Crypto Accountant Defined
A crypto accountant is an expert in the accounting and taxation of cryptocurrency. They possess a deep knowledge of traditional accounting principles and distinctive aspects of the crypto market.
Crypto accountants guide individuals and businesses through the complex world of crypto taxes, ensuring compliance with IRS regulations and maximizing tax benefits.
Crypto accountants are well-versed in various crypto transactions, such as buying and selling crypto for fiat currency, swapping one cryptocurrency for another, and earning new tokens through activities like staking and liquidity mining.
They can offer insights and advice on optimizing taxable positions, identifying tax liabilities, and calculating capital gains and losses.
Why Do You Need a Crypto Accountant?
Navigating the world of crypto taxes can be highly perplexing for individuals and businesses alike. The IRS has guided the taxation of cryptocurrencies.
Still, the ever-evolving nature of the crypto market and the need for thorough regulations make it challenging to stay current; here is where a crypto accountant can make a significant difference.
1. Expertise in Crypto Taxation
Crypto accountants have in-depth knowledge of the IRS guidelines on cryptocurrency taxation. They understand how various crypto transactions are classified for tax purposes and can help you calculate your tax liabilities accurately.
By leveraging their expertise, you can ensure you follow the correct tax rules and accurately report your crypto activities.
2. Maximizing Tax Benefits
Crypto accountants are skilled at identifying opportunities to minimize tax burdens and maximize tax benefits. They can help you optimize your taxable positions by using tax loss harvesting strategies to offset capital gains with capital losses.
With their guidance, you can take advantage of available tax deductions and credits, ultimately saving money on your tax bill.
3. Avoiding Costly Mistakes and Penalties
The consequences of non-compliance with crypto tax regulations can be severe. Failing to report cryptocurrency transactions or inaccurately reporting them can result in penalties, fines, and legal implications.
A crypto accountant can help you avoid these risks by ensuring that your tax filings are precise, complete, and adhere to IRS requirements.
How Popular is Crypto in the USA?
Cryptocurrency has gained significant traction in the United States, with many Americans investing in digital assets. According to recent research, approximately 1 in 4 Americans has invested in cryptocurrencies, showing that crypto adoption is rising despite market volatility.
As of March 2022, around 50 million Americans are current or previous crypto investors; 59% of these investors plan to increase their crypto investments over the next six months.
The increasing interest in crypto assets indicates a growing need for crypto accountants who can help individuals navigate the complex world of crypto taxation.
>>Related Read: How To Calculate Your Crypto Taxes<<
How Does the IRS View Cryptocurrency?
Understanding how the IRS views cryptocurrency is crucial for proper tax compliance. The IRS treats virtual currency, including cryptocurrencies, as property for federal income tax purposes. Cryptocurrencies digitally represent value that can work as an exchange, a unit of account, or a store of value.
While some virtual currencies may operate similarly to fiat currencies, they do not have legal tender status in the United States. Selling, exchanging, or using virtual money to pay for goods or services and holding virtual currencies as an investment can have tax consequences and be a tax liability.
The tax implications of crypto assets hinge on the nature of the transactions. In most cases, the tax rules governing property transactions also apply to virtual currency transactions.
If an investor decides to sell or otherwise get rid of virtual currency, they must account for any capital gains or losses they incur. Additionally, specific transactions, such as hard forks, airdrops, mining, and staking, may be considered income and subject to taxation.
It is important to note that if an investor owns multiple units of the same virtual currency with varying basis amounts, they should pinpoint the basis of the units when calculating gains and losses. If they cannot, the IRS considers the standard accounting method the first-in, first-out (FIFO) method.
The IRS has also issued new guidance regarding non-fungible tokens (NFTs), stating that NFTs may be collectibles if the underlying asset is determined to be a collectible under Section 408(m)(2) of the tax code. Long-term gains from NFTs deemed collectibles should be at a higher taxation rate of 28%.
Accounting for Cryptocurrency: Capital Gains Tax
One of the critical aspects of crypto accounting is calculating and reporting capital gains tax. Capital gains tax is applicable when an individual or business disposes of cryptocurrency, such as selling it for fiat currency or swapping it for another cryptocurrency.
When Does Crypto Trigger a Capital Gains Tax Event?
A capital gains tax event happens when you dispose of your crypto. Disposing of crypto includes:
- Selling crypto for fiat currency.
- Swapping one cryptocurrency for another.
- Spending crypto to purchase goods and services.
The time an investor has held the crypto asset affects the tax rate calculation. If an investor holds the asset for less than one year, they will pay short-term capital gains tax on any profit.
If they keep the investment for more than one year, they will pay long-term capital gains tax on any profit. You can offset your losses against gains. An additional $3,000 can be offset against regular income each financial year.
Cost Basis and Fair Market Value
Calculating capital gains or losses involves determining the cost basis of the cryptocurrency. The cost basis is the amount an investor spends in USD to acquire the virtual currency, including fees, commissions, and other acquisition costs.
In cases with no apparent basis, such as mining rewards or being paid in crypto, you should use the asset’s fair market value in USD on the day you acquired it.
Choosing the Right Accounting Method
Investors who have disposed of multiple units of the same cryptocurrency can decide which they’ve disposed of by using the specific identification accounting method.
If identification is not possible, the IRS allows the use of accounting methods such as first-in, first-out (FIFO), last-in, first-out (LIFO), or highest-in, first-out (HIFO). It is crucial to maintain records to prove the chosen accounting method.
Accounting for Cryptocurrency: Income Tax
In addition to capital gains tax, certain crypto activities may trigger income tax obligations. Income tax applies when an investor earns new tokens from activities such as staking, liquidity mining, receiving airdrops, or earning interest on crypto loans.
Staking and Yield Farming
Staking crypto assets as part of a proof-of-stake consensus mechanism or in decentralized finance (DeFi) protocols can result in earning new tokens. These earned tokens are considered additional income and may be subject to income tax.
However, it is essential to note that the tax treatment may differ. It depends on the specific protocol and the manner of distribution of rewards. Some protocols payout rewards in new tokens, while others utilize liquidity pool tokens or generate income through yield farming.
Mining and Airdrops
Crypto mining, where individuals contribute computing power to secure blockchain networks, is viewed as ordinary income by the IRS. The fair market rate of mined cryptocurrency on the day it is received determines the income amount.
Airdrops, which involve receiving free tokens from projects or hard forks, are also considered taxable income. Accurate reporting of these income forms is crucial to ensure compliance with IRS regulations.
Selecting the Right Accounting Method
When accounting for crypto transactions, selecting the appropriate accounting method is essential for accurate tax reporting. Different accounting methods, such as first-in, first-out (FIFO), last-in, first-out (LIFO), or highest-in, first-out (HIFO), can be used to determine the cost basis of crypto assets.
The specific identification method allows investors to choose which units of cryptocurrency they have disposed of, but it requires detailed record-keeping. If particular identification is impossible, the IRS permits the use of alternative accounting methods.
It is essential to consult with a crypto accountant to determine the most suitable accounting method for your specific circumstances.
Reporting Crypto Taxes to the IRS
Correctly reporting crypto taxes to the IRS is crucial for maintaining compliance and avoiding penalties. The following steps outline the process of calculating and reporting crypto taxes:
- Calculate the Cost Basis:
Determining the cost of each crypto asset or the fair market value in USD on the day it was acquired.
- Identify Taxable Transactions:
Based on IRS guidelines, classify each transaction as either a capital gains tax event or an income tax event.
- Calculate Capital Gains and Losses:
Determine the capital gains or losses from every crypto disposal, separating short-term and long-term gains. Calculate the net capital gain or loss.
- Report Crypto Income:
Identify the fair market value of any crypto income received in USD and report it accordingly. Use Schedule 1 for income tax reporting or Schedule C for self-employed individuals and businesses.
- File the Tax Forms:
Prepare and file the necessary tax forms, such as Form 1040, Schedule D, Form 8949, and any required documents based on your circumstances.
We recommend using a crypto tax tool to simplify calculating and reporting crypto taxes. They can also help automate the tracking of crypto transactions, calculate tax liabilities, and generate IRS-compliant tax reports.
Frequently Asked Questions (FAQs) About Crypto Accounting
In conclusion, crypto accounting is crucial in maintaining compliance and optimizing tax outcomes for individuals and businesses involved in the crypto space.
Working with a crypto accountant can provide valuable guidance and ensure accurate tax reporting, minimizing the risk of penalties and legal implications.
By understanding the IRS guidelines, selecting the appropriate accounting method, and utilizing reliable crypto tax tools, you can confidently navigate the complexities of crypto taxation.
Stay current, get professional advice when needed, and make informed financial decisions in the ever-evolving world of cryptocurrency.