As of today we have not seen final regulations. The article below is based on the current state of the proposed regulations. We will update you as soon as the Treasury and the IRS issue final regulations.
The proposed crypto tax regulations will significantly impact your tax reporting obligations when it comes to digital asset sales. If you are an American taxpayer striving to remain compliant by reporting all your digital asset trading activities on your tax returns, here’s what you should expect.
A Significant Increase in Tax Forms
Starting in the tax year 2025, every crypto platform - including centralized and decentralized exchanges - that you transact with will send you a tax form. What does that mean for the Web 3 game or the NFT (non-fungible token) marketplace you traded on? They will also have to issue you a tax form.
Form 1099-DA, the expected form the IRS will use to report crypto transactions, will be issued by every platform considered a broker under the reporting rules. This term is defined broadly enough to mean that almost everything you do in Web 3 will come with a tax form (exceptions for validating protocols - mining and staking).
Copies of these tax forms will be sent to the IRS and state tax authorities, just like any other tax form. This means that you have to report all income from all these tax forms, which should be simple in theory, but duplicate reporting and missing tax information will complicate your task as a compliant taxpayer.
What is the purpose of these tax forms? Digital assets (virtual currency, cryptocurrency) are considered property for tax purposes in the US. Yet, there is no reporting system to help taxpayers figure out and report their taxable income. Due to this lack of information, there is also a lack of knowledge of the Internal Revenue Service to enforce.
The soon-to-be-released forms are aimed at helping taxpayers easily report their long-term capital gains as well as their short-term capital gains derived from transacting with digital currencies. Brokers would also have to report ordinary income, such as mining or staking. They also aim to provide the IRS with more visibility as they suspect about 75% of crypto traders are non-compliant.
Duplicate Reporting and Cost Basis Issues
What is Duplicate Reporting?
Duplicate reporting occurs when more than one broker reports the same transaction to the IRS. This can happen because the current regulations may lead multiple platforms to report the same crypto activity.
How Does This Affect You?
Increased Audit Risk: If you receive two 1099 forms for the same transaction (say selling Bitcoin), and you only report one, the IRS may think you're underreporting your income, increasing your audit risk.
Paying More Tax Than Owed: Reporting both without adjustments could lead to paying taxes twice on the same income. Imagine you sold Bitcoin for $10,000. Two 1099 forms for this sale could mistakenly make it look like you sold $20,000 worth of Bitcoin, doubling your tax bill.
What is Cost Basis and Why Does it Matter?
The cost basis is what you originally paid for your crypto. When you sell, the difference between the sale price and the cost basis is your capital gain (or loss).
Incorrect Cost Basis Reporting: If the cost basis is misreported (for example, as $0 when you paid $5,000 for Bitcoin), your taxable gain will appear larger than it is. Selling that Bitcoin for $10,000 will show a $10,000 gain instead of the correct $5,000 gain, leading to higher taxes.
Tracking Transfers: Each time you transfer crypto - from one wallet to another or between exchanges - it complicates tracking the cost basis. Without accurate tracking, you might report a higher gain and, as a result, overpay your taxes.
What Can You Do?
Track Your Transactions: Keep detailed records of all your crypto transactions, including dates, amounts, and platforms used.
Review Your 1099 Forms: Check for duplicate reports and ensure your cost basis is reported correctly.
Adjust Your Tax Forms: If necessary, adjust Form 8949 to account for duplicates and correct your cost basis.
Seek Professional Help if Needed: Understanding and navigating these issues can be complex. If you're uncertain, schedule a free consultation with our crypto tax team.
Track Your IRS Tax Record: Every taxpayer has an official tax record maintained by the IRS. This gets updated with information from filing forms 1099, W-2, K-1, etc. With a proactive membership, CryptoTaxAudit can track this for you on a regular basis, so the moment there are any issues, you will be the first to find out.
Being Able to Use Fewer Platforms as a US Citizen
We have already seen the departure from the US start in crypto. Bittrex and KuCoin are among the major exchanges to no longer allow US citizens to use them. The regulations will cause many reporting challenges to decentralized finance (DeFi) platforms, likely leading many of them to exit the US market instead of fully complying with the reporting requirements, which would include collecting KYC information and reporting trades for all US taxpayers.
With fewer platforms available to US crypto investors and a renewed interest in digital assets by traditional finance, more US citizens are expected to invest using more regulated brokers. Over time, this will consolidate the reporting for many. Any advanced or intermediate crypto investor will still need to diligently track the correct data using a crypto tax tool.
Challenges in Your Tax Information Being Congruent with Your Current Crypto Tax Tool
Every crypto investor who has remained compliant with tax regulations and properly reported their crypto taxes is currently using one of several crypto tax tools available in the market. These tools gather your transaction history from every exchange and wallet you use in order to put it all together to create accurate tax reports.
The issue is that these tools are not all created equally. A user will get different results depending on which tool is used, and this is due to the need for more data or tax standards when sharing this information. Consider that the margin for user error is also significant, and the reality is that many taxpayers are filing a number based on user and system faults. Diligent users will be able to audit their reports and fix any data issues, but chances are your calculations will not align with what your exchange will report.
But if it’s a different tax year, it shouldn’t matter. And it won’t if you buy and sell the crypto within the same tax year and the same platform. However, sales across multiple platforms and tax years (purchased in 2020 and sold in 2023 on a different exchange) will see a higher likelihood of error in the correct cost (tax) basis being reported.
Why does the correct basis matter? Capital gains are based on the gain - the proceeds (fair market value) less the cost basis. So when you sell a Bitcoin for $35,000 that you purchased for $25,000, you have a $10,000 gain > 35,000 - 25,000. But what happens if the cost basis is reported as 0? Then, you would show a gain of $35,000. Assuming a 20% tax rate, this difference is $5,000 of additional taxes if you don’t correctly report your tax basis.
We will likely see the new Form 1099-DA with many tax basis issues during the first few years of its life. For these years, it will be critical for digital asset investors with large portfolios to keep good records documenting their tax basis, forms 1099, and tax reports. It will be essential to understand how to adjust incorrect tax basis on Form 8949.
More Information About Your Trading Available to the IRS
The IRS expects over 8 billion Forms 1099-DA to be submitted by crypto brokers for their American customers. This means that any platform you trade on will share your trading history with the IRS if it wants to remain compliant. It is critical to comply with all local tax laws and report all gains, losses, and taxable income from crypto. The IRS will be better equipped than ever to detect non-compliance.
Even taxpayers who are fully compliant with all tax rules will need help to maintain adequate records. We have already acknowledged that there will be challenges with the accuracy of forms 1099-DA. If we also consider the volume of duplicate reporting that the IRS will receive, this means that taxpayers will be left to verify to ensure there is no duplicate reporting and make the required adjustments on Form 8949 to ensure they are reporting all 1099s but not over-reporting.
The upcoming tax regulations may not complicate too much for simple traders and investors, those who only use one exchange or often buy and hold. But for most crypto traders utilizing a plethora of cryptocurrency exchanges and crypto wallets, the reporting will become challenging to ensure the accurate reporting of your crypto tax liability.
At CryptoTaxAudit, we have close to ten years of experience helping U.S. taxpayers with crypto taxes. Schedule a free consultation if you need help navigating these complex crypto tax regulations. We also have other resources for those taxpayers who may want to try self-preparing and reporting to ensure that they always stay one step ahead of the IRS.