Uncle Sam Dives into Crypto — Implications for CPAs

by Kristina Kostovski, CPA, Traphagen CPAs & Wealth Advisors | December 13, 2021

Bitcoin, the oldest and most popular cryptocurrency created in 2008, paved the way for thousands of different altcoins available on today’s market. Cryptocurrency quickly gained popularity as transactions could be performed quickly with no involvement of an intermediary to facilitate these transactions. Coupled with anonymity, transparency, worldwide use and access, crypto became a popular choice for remitting and receiving payments.

Bitcoin’s first large price increase occurred in 2010; it jumped from less than a penny to eight cents. Celebrity endorsements inspired the world to jump into investing and trading cryptocurrency. The value popularity of cryptocurrency reached a high as Bitcoin broke $66,990.90 a coin on Nov.10, 2021. Crypto’s journey into the mainstream markets hit a milestone in October of 2021, when the first exchange-traded fund linked to bitcoin futures made its stock market debut; this allowed anyone to buy and sell a bitcoin-backed financial product on the stock market. ProShares, the Maryland-based company behind the ETF, saw its product top $1 billion in trading volume on its first day. However, what many have failed to recognize are the tax implications.

Factoring in Taxes

A required question on an individual’s 2020 1040 Schedule 1 was “At any time during [the tax year], did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This very question alluded to the IRS’s increased scrutiny of cryptocurrency transactions as its popularity grew. A taxable event occurs when a taxpayer trades cryptocurrency to fiat currency like the U.S. dollar, trades one cryptocurrency for another cryptocurrency, uses cryptocurrency to pay for goods and services or earns crypto as income.

Capital gains will be realized when the crypto received is sold. The gain or loss will be the difference between the adjusted basis in the virtual currency and the fair market value (FMV) of the amount received in virtual currency. Because wash sale rules currently do not apply to crypto, all losses can be used to offset gains. If one regularly trades cryptocurrency, it may be beneficial to make a mark-to-market election, given the complexity and multitude of trades.

Income generated from staking or mining crypto should be recognized as ordinary income. Simply put, mining crypto is the process of solving complex mathematical problems and using computing power to add new transactions to the blockchain. Despite mining income being subject to self-employment tax, the income is considered ordinary in nature and, therefore, it can be reported on schedule C where expenses may then be deducted. Staking crypto, on the other hand, is similar to keeping money in the bank and earning interest.

In 2019 alone, the IRS issued more than 10,000 warning and action letters to non-compliant crypto investors. Although crypto exchanges may not issue 1099s to investors and traders, it is the individual’s responsibility to properly report these transactions on their tax return. Don’t leave it to Uncle Sam to determine your liability!

Kristina  Kostovski

Kristina Kostovski

Kristina Kostovski, CPA, is a senior accountant at Traphagen CPAs & Wealth Advisors. She is a member of the NJCPA and serves on the Student Programs & Scholarship Committee, the Emerging Leaders Interest Group, the State Taxation Interest Group and the Federal Taxation Interest Group.

More content by Kristina Kostovski:

Leave a comment