Start planning with our FREE 2024 Crypto Tax Playbook
The emergence of cryptocurrencies like Bitcoin, Ethereum, and stablecoins over the past decade has created new challenges related to accounting and tax reporting. Unlike fiat currencies like the US dollar that are issued by governments, cryptocurrencies are decentralized digital assets that use encryption techniques to control the creation of monetary units and verify transfers.
While innovation in blockchain technology and crypto continues at a rapid pace, guidelines and regulations surrounding cryptocurrency accounting and taxes continue to evolve. Both businesses accepting cryptocurrency payments and individual crypto investors must understand a few key concepts:
Having a clear crypto accounting and bookkeeping process is key for both businesses handling cryptocurrency transactions as well as individuals holding any form of virtual currency. Continue reading to learn crypto accounting essentials.
Any merchants, applications, platforms, or other business accepting cryptocurrency as payment for goods/services needs to understand the accounting and tax implications.
Tax Rules for Crypto Payment Transactions
In 2014, the IRS issued initial guidance (Notice 2014-21) making it clear that cryptocurrency is treated as property for US federal tax purposes. This means specific tax rules apply when a business receives crypto coins or tokens as payment:
Essentially, any business accepting cryptocurrency payments must record the type of coins received, date acquired, fair market value in US dollars, and associated sales tax due for each transaction.
This example illustrates cryptocurrency payment tax implications:
As this shows, the volatility of cryptocurrencies makes accurate record keeping and accounting essential to avoid tax headaches or issues later on.
Cost Basis Accounting for Crypto Payments
A critical aspect of crypto accounting for businesses is tracking cost basis, which is used to calculate capital gains or losses when the company later sells or converts coins received as payment.
Cost basis refers to the fair market value (FMV) of the cryptocurrency on the date and time it was received by the business. This FMV becomes the business’ cost basis if they later redeem crypto accepted for goods/services.
Properly tracking cost basis involves:
Again looking at Ace’s App Shop example:
Having records on the cost basis of ETH payments allows Ace’s Apps to accurately report capital gains later on.
Crypto Accounting Systems and Software
Given the complexities around accepting crypto payments, specialized accounting systems and software can greatly simplify record keeping and tax reporting for businesses.
Some features to look for include:
Top crypto-centric accounting software platforms used by businesses include:
Along with increased business adoption, many individuals now hold cryptocurrency as investments. All crypto investors in the United States should be aware of how capital gains taxes apply to virtual currencies before filing their tax returns:
Cryptocurrency Capital Gains Tax Rates
Since crypto coins/tokens are deemed property by the IRS, they are subject to capital gains tax rates when sold at a profit or exchanged for another coin. This means:
For example, John purchased 0.5 BTC in January 2022 for $20,000 and sold it in February 2023 for $25,000 would have:
Whereas long term capital gains over 1 year have preferential rates between 0%, 15% and 20%.
Cryptocurrency Transactions and Tax Reporting
It’s critical for crypto investors to understand every transaction is potentially taxable, not just selling for cash. Under IRS rules Notice 2014-21:
Examples of common reportable crypto transactions:
So beyond just buying and selling crypto for fiat currency, every conversion or transfer triggers capital gains/losses calculations.
Avoiding Cryptocurrency Tax Pitfalls
Given the need to track details like date acquired, cost basis, and fair market value across exchanges, wallets, DeFi protocols and other platforms – manual calculation of crypto taxes gets very complex. Without the proper records, some common issues include:
Thankfully cryptocurrency tax software automates the import of historical transaction data and generates completed IRS tax forms. Continue reading to learn more.
Cryptocurrency Tax Reporting Software
To eliminate manual work tracking cryptocurrencies across different accounts and to avoid costly tax errors – specialized crypto tax solutions have emerged.
Leading platforms such as Contracting, Koinly, ZenLedger, and CryptoTrader.Tax offer:
For most crypto investors, using cryptocurrency tax software saves significant time and provides confidence that IRS regulations are adhered to properly during tax season.
Whether operating a business earning cryptocurrency or buying/selling digital tokens as an individual – documentation is critical not just for accounting accuracy but meeting IRS regulations.
Why Proper Record Keeping Matters
Complete and accurate records serve multiple purposes:
Without proper documentation of transactions, costs basis amounts, fair market values and more – cryptocurrency taxes can quickly become complex and high risk.
Types of Crypto Records to Maintain
According to IRS guidelines on virtual currencies (PDF), records that individuals and businesses should keep include:
Ideally records are maintained in an IRS-compliant file format like CSV, Excel or PDFs for easy importing into accounting systems or audit review.
Records should be kept for at least 3 years after the date the taxes are filed according to general IRS guidance (Topic No. 305). Some experts recommend keeping 7 years of cryptocurrency records just to be safe.
Crypto Accounting Record Keeping Best Practices
Good record keeping habits regarding cryptocurrency activity includes:
Making record keeping part of regular processes will save significant time and potential penalties during tax season down the road.
As highlighted in this comprehensive guide, properly tracking cryptocurrency transactions and staying compliant with US tax regulations is critical yet complex for both business owners and individual investors.
Some key takeaways on crypto accounting essentials:
Without the proper crypto accounting foundations – preparing accurate taxes can quickly become overwhelming. But hopefully this overview has provided both better understanding of IRS virtual currency expectations as well as resources to simplify staying compliant.
For more information on cryptocurrency accounting, tax rules, common pitfalls, and software solutions explore the following additional resources:
Follow the above accounting and reporting best practices to avoid any costly tax surprises. Reach out to a cryptocurrency CPA for personalized tax planning tailored to your specific situation.
Onchain Accounting stands as your vigilant financial co-pilot, ensuring compliance and peace of mind.
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