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Profits on Crypto Investments are Taxable; Here are Steps That Help you Avoid Legal Trouble

It is important to recognize and tackle the frequently disregarded facet of crypto investments—taxation.
Cover Image Source: Crypto Taxes | Unsplash | Photo by Campaign Creators
Cover Image Source: Crypto Taxes | Unsplash | Photo by Campaign Creators

Despite volatility persisting and multiple scams shaking up the blockchain ecosystem, the cryptocurrency market has continued to surge, with Bitcoin surpassing $73,000 and the overall market cap exceeding $2.5 trillion. Investors still rely on crypto as a viable asset, and many are reaping substantial profits too. But as unregulated as cryptocurrencies may be, it's important to acknowledge and address taxation norms associated with them, to avoid severe penalties imposed by the IRS, and to ensure due diligence.

Image Source: Unsplash | Kanchanara
Image Source: Unsplash | Kanchanara

A recent study conducted by Divly, a company dedicated to simplifying crypto taxation, reveals that the majority of crypto owners in the United States have not reported their activities to the IRS. In 2022, only approximately 1.62% of U.S. crypto owners disclosed their holdings to the IRS.

Underreporting crypto transactions is a common oversight among investors, whether due to ignorance of tax obligations or inadequate record-keeping. But failing to accurately report all crypto transactions can result in significant financial and legal consequences. The IRS has intensified its efforts to detect underreporting via advanced tech and has even hired crypto experts to ensure tax compliance.

Image Source: Getty Images | Photo by Scott Olson
Image Source: Getty Images | Photo by Scott Olson

"It’s a really big enforcement area for the IRS right now," says Brian R. Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa. "They’re generating a lot of publicity in going after people who hold, trade, or use cryptocurrency. Those people can be a target for audit or compliance verification."

"The IRS and FBI are getting better at tracking and tracing Bitcoin as part of criminal investigations," he adds. "And they can freeze assets if needed, he adds."

Airdrops and forks, which involve the distribution of new cryptocurrencies to existing token holders, often catch investors off guard when it comes to taxation. Despite the allure of receiving free tokens, failing to report income from airdrops and forks can result in penalties and tax liabilities. Proceeds from airdrops as well as forks are both considered taxable income by the IRS and must be reported at their fair market value at the time of receipt.

"This increased reporting may cause some issues for those who haven’t disclosed cryptocurrency transactions before," says Harris. "It’s in people’s better interest to start reporting."

Pexels | Nataliya Vaitkevich
Image Source: Pexels | Photo by Nataliya Vaitkevich

To ensure compliance with tax regulations regarding airdrops and forks, investors need to seek guidance from tax professionals familiar with cryptocurrency taxation. Consulting with experts can provide clarity on reporting requirements and help investors accurately report these transactions on their tax returns.

Many investors overlook the broader tax implications of crypto transactions. Activities such as spending crypto at retailers and swapping one cryptocurrency for another can trigger tax liabilities, each with unique implications for taxation.

"There is potentially more informational reporting that will occur in the future, and these exchanges will be disclosing more information about digital assets and cryptocurrency," says Harris. To avoid unexpected tax bills, investors must have a thorough understanding of the tax implications associated with various crypto activities.