Common Crypto Tax Pitfalls You MUST Avoid

How is Cryptocurrency Taxed?

Before we begin outlining crypto tax pitfalls and the issues which come with them, we ought to first address how crypto is taxed. Crypto is taxed as a capital gain, which means that anything you earn from selling it will be taxed. For example, if you purchase $1,000 of Ethereum and sell it for $5,000, then you are subject to $4,000 of capital gains tax ($5,000 - $1,000 = $4,000).



This does not mean that all your gains are taken by the IRS, however. That depends on a variety of factors, including your filing status, income, and how long you hold onto your crypto assets. If you are a single individual making $85,000 annually, for example, you are subject to 22% in short term capital gains taxes.

To learn more about capital gains taxes and how they affect your crypto portfolio, connect with a tax professional.

Crypto Tax Pitfalls for NFTs

Starting with non-fungible tokens (NFTs), which are digital representations of art or music, we come against the first of our crypto tax pitfalls. The IRS has not issued any specific NFT tax laws, which makes many assume that these tokens will not be subject to tax. This assumption is false, as NFTs technically fall under the “collectible” tax classification. This means that any NFT sold or traded on the OpenSea or other NFT trading platforms will be considered by the IRS as a unique work of art, comparable to anything which can be bought at a traditional art auction. This is particularly important because NFT gains can be subject to a slightly higher tax rate than regular cryptocurrencies.

The Solution

Unlike classic cryptocurrencies like Ethereum or Bitcoin, it is difficult to properly assess fair market values for NFTs. Since these are collectible artistic assets, they have to be appraised in order to determine true value, and thus accurate taxable gain or loss. Because this can quickly become a complex affair, it is important to consult with a qualified tax professional. A short one hour conversation could be the difference between paying thousands to the IRS, or just a few hundred.

Not reporting crypto is a HORRIBLE idea

Many crypto enthusiasts rightly point out that paying taxes on crypto goes completely against the ethos of the crypto market and the entire decentralized finance (DeFi) movement. Indeed, the fact that a centralized agency such as the IRS can require individuals to pay taxes on a currency which is built on privacy and autonomy is a direct contradiction. However, it is the IRS which has not only the full force of the federal government behind it in order to enforce its rulings, but the IRS also has the compliance of many major crypto exchanges.

Far too many cryptocurrency investors are under the impression that the IRS has no way of knowing your crypto activity. This is not completely true. In actuality, the IRS is actively looking for methods to track your crypto movements. At the moment, their primary method is through having major crypto exchanges like Binance and Coinbase send reports on what you spent and what you earned, and comparing that to what you report (or don’t report) on your tax return. You can read more about this in our discussion on the 2021 Infrastructure Bill.

If the IRS finds out that you have been withholding information, and thus not paying your taxes, you will be liable for a variety of aggressive penalties brought on by the United States government. That’s probably the worst of the crypto tax pitfalls you could deal with!

Crypto Tax Pitfalls of Record-Keeping

Clearly, you want to keep in the good graces of the IRS. In such a case, your record-keeping is absolutely crucial to everything within your tax return. It isn’t uncommon for crypto enthusiasts to lose records due to exchange closures or, worse yet, simply not keep records at all. Crypto record-keeping is incredibly important in the event that the IRS accuses you of fraud or some form of tax evasion.

Make sure to keep all your source data in one secure location, as the ultimate burden of proving your honesty on your tax return information is on you. Many crypto tax pitfalls simply start with inconsistent or nonexistent recordkeeping, and this is something which can be easily fixed.

Crypto Tax Pitfalls of Positivity

Everyone appreciates some positivity every now and then, but when it comes to tax season, some taxpayers can be a little excessive. Indeed, a lot of taxpayers realize that they can use write offs, deductions, credits, and losses in order to cut down their tax payment requirements. This is great at first, until one realizes that the IRS scrutinizes these items more than they do under-reported or omitted income.

A lot of the crypto tax pitfalls that taxpayers fall into in this regard comes from a misunderstanding of tax law, and a misuse of deductions and write offs. In fact, it isn’t uncommon for the IRS to notice that people are trying to use obsolete sections of the tax code to deduct their tax obligations. Although the enthusiasm is there, the experience and knowledge certainly isn't. This is why it is so highly recommended that taxpayers connect with tax professionals before starting on their taxes.

Yoke Tax employs a variety of tax pros with over 20 years of experience who are ready and willing to help you retain as much of your crypto earnings as possible, without sacrificing it all to Uncle Sam! Tax season does not have to be a complicated affair, and a smart tax pro can help you save money and set you up for future success. Just let us handle the numbers for you, and never worry about crypto tax pitfalls again.