Use this tax checklist to help you stay compliant.
On June 7, 2022, U.S. Senators Cynthia Lummis and Kirsten Gillibrand introduced the bipartisan Lummis-Gillibrand Responsible Financial Innovation Act to help drive greater clarity, transparency, and consumer protection in the digital asset ecosystem. If enacted in its current form, the bill will provide a multiagency federal framework for regulating digital assets and the related technology.
Whether this specific bill passes intact or with changes, legislators and regulators clearly have digital assets under a magnifying glass. It is only a matter of time before a comprehensive system of tax rules and guidance emerges.
Here is a checklist of 10 tips for individuals and organizations preparing for income tax compliance around digital assets, as identified in our recent webinar.
- Keep good records of all transactions. Record when you buy, sell, exchange, receive, earn, or dispose of digital assets. If you have entered into more than a handful of transactions, consider using one of the crypto tax tracking software packages available. The information needed to substantiate the positions taken on tax returns includes the date, amount, cost basis, holding period, transaction fee, and fair market value (FMV) in U.S. dollars on the date of the transaction.
- Account for transactions on all wallets and exchanges. No exceptions. If the crypto tax tracking software – or whichever solution you are using to record transactions – does not support certain wallets or accounts, you can upload a comma-separated values (CSV) file or manually enter the data.
- Make sure transfers of digital assets between wallets, accounts, or addresses you own are not counted as sales. Transfers between multiple digital wallets, accounts, or addresses of the same owner are not taxable. However, if not all wallets, accounts, or addresses are connected or accounted for, the crypto tax tracking software could assume that such transfers are sales and incorrectly generate reportable gain or loss on the transfers.
- Choose a cost basis method and be consistent. If you decide to change the method, consider whether to file an accounting method change with the IRS or to amend prior year tax returns to report the proper basis and related gain or loss. The IRS allows the first-in, first-out and specific identification methods.
- Consider the tax consequences of buying nonfungible tokens (NFTs) with virtual currency. If you use virtual currency, such as ethereum (ETH) or solana (SOL), to purchase an NFT, you essentially “sold” your ETH or SOL, which is a taxable event. The purchase price of the NFT minus the transaction fee is your sale proceeds. Comparing such proceeds to your cost basis, the difference is a gain or loss reportable on your tax return.
- Understand the tax implications of creating revenue-generating NFTs. If you founded or collaborated on an NFT project, you should work with a tax adviser to understand your tax filing obligations on the revenue earned at mint and subsequent sales.
- Pay attention to the tax basis in digital assets received as compensation. If you receive compensation in digital assets, the income reported on Form W-2 or Form 1099 is your tax basis in the digital assets received. Such tax basis could be different from the tax basis assigned by the crypto tax tracking software due to the potential variance in FMV. Note that you will have taxable income even if the payer does not provide you with a Form W-2 or Form 1099.
- Rely on experienced tax professionals. If you have significant or material transactions in decentralized finance protocols, such as lending, borrowing, and liquidity pool, you should work with a tax adviser, as the rules are difficult to understand and implement on your own.
- Try to stick with a single crypto tax tracking software solution. If you switch crypto tax tracking software, you could end up with different gains and losses for each year. These discrepancies arise for numerous reasons, including the source of FMV on crypto-to-crypto transactions. If you see material variances, work with a tax adviser to evaluate and assess the final output and amend prior year tax returns, if needed.
- Stay current. Know the latest IRS guidance, including FAQ, to confirm that transactions in digital assets are accurately reported on your tax returns. Learn more.