5 US crypto tax myths busted

31 July 2023

For Americans with money to invest, the crypto industry’s pace of development can be confusing. Whether hype or reality – and, often, it’s a bit of both – the stories we read online and the conversations we hold over the barbeque can leave us unsure of what to think, what to take seriously and what to disregard.

In this article, CountDeFi debunks several myths surrounding crypto taxes. Brace yourself for a healthy dose of reality as we clear up any misconceptions you may have about crypto assets’ taxable status, the less well-known tax-triggering events, the traceability of your transactions, the utility of crypto tax software, and more.

Crypto tax myth #1: You don’t have to pay tax on crypto

Fake news. As the man on the $100 bill liked to say, nothing’s as certain as death and taxes.

This erroneous belief may result from a lack of understanding of tax regulations or perhaps from misinformation circulating within certain online communities. Mostly, though, we think it’s wishful thinking. In which case, dear reader, we’re sorry to be the bearer of bad news: You’re 100-percent on the hook for any profits you’ve made from crypto in recent years. 

The truth is that the crypto industry is maturing fast. Its place in the world of finance has changed. It’s now almost fully integrated into the mainstream. And it’s a lot more regulated than ever before. It took some time for tax authorities to catch up with developments in the space, but income derived from virtual assets is now very clearly in the sights of the US Internal Revenue Service (IRS). 

The federal agency classifies virtual currencies as property and applies the same general tax principles to it that it would real estate or stocks and bonds. The agency has issued rules to consumers and businesses for reporting crypto transactions and income derived from them.

You’re 100-percent on the hook for any profits you’ve made from crypto in recent years.

It’s taken legal action against individuals and entities involved in crypto tax evasion. And it works in concert with other government entities, like the Financial Crimes Enforcement Network, a bureau of the US Department of the Treasury, which focuses on combating money laundering, terrorist financing, and other financial crimes.

Crypto tax myth #2: You only have to pay tax when you cash out

False. Tax may be payable long before you take the off-ramp to the world of dollars and cents.

Too many people mistakenly believe that tax is only payable when crypto interfaces with the fiat world in the form of a sale or exchange – what the IRS refers to as “selling virtual currency for real currency”. Whether you’re just experimenting with crypto, an avid trader, or a miner, it’s important for you to know that cashing out is not the only way to ring up a tax bill in the United States. 

 Here are five other types of crypto-taxable events:

  • Crypto-to-crypto trades resulting in profit
  • Crypto mining rewards
  • Staking and masternode rewards
  • Airdrops and forks
  • Initial coin offerings and token sales

Bartering your cryptocurrency for goods and services – exchanging it directly for something else, without involving fiat currency – can also have tax implications. In such cases, the fair market value of the goods or services received in exchange for the cryptocurrency is treated as taxable income. Taking crypto assets as payment for goods or services is similarly subject to income tax.

Crypto tax myth #3: Your transactions are untraceable

Wrong. Your transactions aren’t just traceable; they’re traceable back to you.

Part of the early hype around cryptocurrencies was the apparent anonymity it afforded its holders, and people still talk about its being more anonymous than trading traditional financial assets on centralized exchanges. As your sixth-grade teacher might’ve told you, though, some adjectives are absolute. As with “perfect” or “immortal”, there are no shades of gray – you’re either “anonymous” or you’re not. And when it comes to crypto, you’re most certainly not.

There are no shades of gray – you’re either “anonymous” or you’re not. And when it comes to crypto, you’re most certainly not.

By design, every one of your crypto transactions is recorded, publicly and forever. Your name is kept off the blockchain, of course, and, in this state, your identity may remain private to a greater or lesser degree, but it isn’t undiscoverable. Not by a long shot. 

Recently, the IRS Criminal Investigations unit partnered with a provider, Chainalysis, on training Ukrainian law enforcement to track Russian-originating crypto transactions. The IRS and other federal authorities make no secret of the fact that they use specialized software systems to trace transactions on the public ledger and identify the owners of crypto wallets. 

Putting a name to it can be as simple as using AI-powered software or getting a subpoena. Like banks, crypto exchanges are also required to comply with international know-your-customer (KYC) regulations, which involve collecting identification information from users when they set up an account. This information can be made available to the government if it suspects tax evasion or incorrect reporting. 

Exchanges and brokers are, in any case, now compelled to share certain crypto transactions with the IRS, providing details about the parties involved and the transaction amounts.

Crypto tax myth #4: Software’s all you need to get the job done

Try again! Software will save you time, but it may not save you money.

Tax reporting is a chore at the best of times and the complex, decentralized crypto ecosystem makes it all the more challenging for crypto traders. No wonder some people look to specialized crypto tax software to ease the burden. We would too, if we believed software alone would get the job done.  

Tax can be seriously inflated without manual intervention by a professional based on their experienced interpretation of the law.

While blockchain technology provides transparency, retrieving and tracking data for tax reporting purposes can be time-consuming and prone to errors. Some people may use multiple wallets or use different exchanges, making it challenging to consolidate and accurately report all transactions. The data obtained from exchanges or wallets may also not always be presented in a format suitable for tax calculations, requiring manual intervention and data manipulation.

Different tax rules – governing short- or long-term capital gains, for example – may apply when it comes to doing the actual math. These calculations require a deep understanding of tax laws and reporting requirements, and incorrect interpretations of the rules can result in errors. 

In many cases, tax can be seriously inflated without manual intervention by a professional based on their experienced interpretation of the law.

Are you paying too much in tax?

Watch CountDeFi’s video on typical problems arising from over-reliance on crypto tax software. 

Crypto tax myth #5: You only have to reconcile data for the year you’re filing

‘Fraid not. The tax you pay depends on data going back to the very start of your crypto journey.

When calculating capital gains, it’s essential to know the original cost basis of the crypto assets in question, which is the price at which they were acquired. However, that historical data may not be readily available or easily consolidated, especially if the individual has been trading or holding crypto for several years. Forks and airdrops further complicate the task.

Let’s say you started trading in 2016 and only declared taxes in 2022. All your transactions from all wallets in the intervening years need to be summarized to determine your tax liability now or in any other tax year.

Get your 101 on crypto tax

Learn the basics about crypto tax in the United States here.

How can CountDeFi help?

No matter where we are in the world, CountDeFi’s crypto tax specialists speak your language. We are passionate about crypto, DeFi, and going bankless. We understand the technology, the ecosystem, and the culture. 

More to the point, we have the knowledge and experience of your country’s tax regime to navigate you through the complex business of crypto tax reporting in pursuit of the best possible outcomes. You can rely on us for all of your on-chain tax and accounting needs. Contact us today.