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Crypto Accounting Essentials for Businesses and Individuals

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Optimizing Your Token Allocation & Compensation Plan for Success in 2023Introduction to Crypto Accounting

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:

  • Cryptocurrencies are treated as property, not currency, for US federal tax purposes – The IRS classes cryptocurrency as property, subject to capital gains tax rules. This means crypto is taxed differently than traditional forms of money.
  • Transacting in crypto is a taxable event – Selling, trading, making payments, converting coins, mining, staking, lending, and more all trigger capital gains/losses.
  • Record keeping is critical for accurate tax reporting – Unlike stocks and bonds, taxpayers themselves must track dates acquired, cost basis, fair market values, and other details across wallets and exchanges.

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.

Crypto Accounting Basics for Businesses

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:

  • Sales tax may need to be charged and remitted, depending on state laws
  • The fair market value (FMV) of coins on date received counts toward gross income
  • Transactions in crypto must be reported on taxes by the business
  • Conversion into fiat currency is also a taxable event

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:

  • Ace’s App Shop lets customers pay for $100 software subscriptions using different coins via Coinbase Commerce
  • On August 1, 2023 a customer pays 1 ETH valued at $1,500 on that date
  • Ace’s App Shop has $1,500 in additional gross income to report
  • If required in their state, they must also remit sales tax such as 7% = $105

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:

  • Recording coins received, acquisition dates, fair market values
  • Using reliable pricing sources like CoinMarketCap
  • Choosing valuation methods like FIFO accounting

Again looking at Ace’s App Shop example:

  • August 1, 2023 – Receive 1 ETH valued at $1,500 = cost basis
  • November 1, 2023 – Convert 0.5 ETH to cash when 1 ETH = $3,000
  • Have capital gain of ($3,000 * 0.5 ETH) – ($1,500 * 0.5 ETH) = $750

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:

  • Payment processor integrations – Automatically pull transaction data from crypto payment services
  • Wallet connections – Connect to wallets to track all transfers and holdings
  • Built-in cost basis tracking – Records cost basis at time payments received
  • IRS form support – Form 8949, Schedule D capital gains calculations
  • Invoicing and billing – Accept crypto for customer invoices and bills

Top crypto-centric accounting software platforms used by businesses include:

Crypto Tax Basics for Individual Investors

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:

  • Short-term capital gains – taxed at your ordinary income rate if held for under 1 year
  • Long-term capital gains – reduced tax rate if held for over 1 year

For example, John purchased 0.5 BTC in January 2022 for $20,000 and sold it in February 2023 for $25,000 would have:

  • Holding period less than 1 year so short-term capital gain
  • Taxable income of $25,000 – $20,000 cost basis = $5,000
  • Taxed at John’s income rate, say 24% federal = $1,200 taxes owed

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:

  • Trading one coin for another, or using coins to purchase goods/services are taxable events
  • Receiving coins from mining, staking rewards, airdrops/hard forks is subject to income tax
  • Even gifts of crypto over $15,000 must be reported

Examples of common reportable crypto transactions:

  • Trading 1 ETH for 2 BTC
  • Using 1 BTC to buy a laptop
  • Receiving $100 worth of DAI coins by staking ether
  • Being airdropped $1,000 worth of tokens from a new DeFi platform

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:

  • Inaccurate cost basis – Can’t prove dates coins were acquired or values paid leading to penalties
  • Lost transactions – Some taxable events like airdrops go unreported without complete records
  • High tax bills – Short-term trades or cashing out at peak bull market prices causes more owed

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:

  • Automated transaction imports – Syncs buy/sell history from exchanges and wallets
  • Portfolio tracking – Records income, trading profits/losses, fees paid
  • IRS forms preparation – Creates complete 8949, Schedule D capital gains/loss PDFs
  • Audit protection – 3-7 year audit protection services
  • Tax loss harvesting tools – Optimize toward lower tax bills

For most crypto investors, using cryptocurrency tax software saves significant time and provides confidence that IRS regulations are adhered to properly during tax season.

Crypto Record Keeping Requirements

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:

  • Verify dates and cost basis amounts paid for coins
  • Track income from activities like staking rewards, mining or gifts received
  • Enable reliable calculation of capital gains or losses
  • Provide supporting documents if ever audited by tax authorities

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:

  • Dates acquired – Purchase confirmations from exchanges or wallet timestamps
  • Cost basis amounts and fair market values – Account statements, crypto pricing data
  • Description of transactions – Exchanges trades, blockchain transfers, etc
  • Digital wallet records – Public wallet addresses, access logs, statements

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:

  • Download regular account statements from exchanges – at minimum annually, ideally quarterly
  • Export transaction history from wallets, DeFi platforms, NFT marketplaces, and anywhere else crypto is stored or converted
  • Maintain paper trails on fiat purchases/sales to exchanges and cold storage transfers
  • Track records in accounting software like Cointracker to eliminate manual work
  • Store records securely – encrypted hard drive or cloud storage recommended

Making record keeping part of regular processes will save significant time and potential penalties during tax season down the road.

Conclusion and Next Steps for Crypto Accounting

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:

  • Cryptocurrencies like Bitcoin are taxed by the IRS as property, not currency
  • Any receipt of crypto payments or conversions triggers taxable events
  • Careful recording of cost basis, fair market values, and documentation is required
  • Blockchain tools provide visibility but foster manual tax work
  • Specialized software automates transaction imports and handles reporting

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.