Navigating Tax Compliance for Digital Assets

Digital asset tax

As individuals and businesses increasingly embrace digital assets and emerging technologies, tax rules get trickier to navigate. This is especially true when it comes to cryptocurrencies and online services. These advancements bring new challenges for companies aiming to meet their tax obligations accurately.

In this article, we’ll delve into navigating tax compliance amid the digital revolution. We’ll explore the taxation of digital assets, including cryptocurrencies and non-fungible tokens (NFTs). It is our goal to provide you with strategies to aid compliance in this rapidly evolving regulatory landscape.

Digital asset taxation

Digital assets encompass a wide range of virtual items, including cryptocurrencies, digital tokens, and more. These assets are treated as property for tax purposes, which means that their sale, exchange, or use in transactions can trigger capital gains and losses that need to be reported. Their value is typically determined by their fair market price at the time of the transaction. Therefore, accurate tax reporting demands meticulous record-keeping and a good understanding of how digital trade may affect tax liabilities. But, because things change fast in this environment, it is crucial to stay abreast of the latest tax regulations.

Cryptocurrency taxation

Cryptocurrency, such as Bitcoin or Ethereum, is a digital asset that operates as a medium of exchange. For tax purposes, cryptocurrencies are treated similarly to other forms of property. This means that when you buy cryptocurrency, there are no tax obligations. However, when you sell it the proceeds may trigger capital gains tax. In the same way, value loss can reduce your taxable income. 

For cryptocurrencies held for more than a year, the long-term capital gains tax rate ranges from 0% to 20%, depending on your income level. However, if held for less than a year, any gains are taxed at your ordinary income tax rate, which can be higher.

Keeping detailed financial records is key to supporting IRS submissions in this regard. To accurately determine the capital gain or loss from the sale or exchange of a digital asset in a taxable event, gather the following details:

  • The specific type of digital asset involved (e.g., Bitcoin, Ethereum)
  • The date and time when the transaction occurred
  • The quantity of units transacted
  • The fair market value of the digital asset at the time of the transaction, expressed in U.S. dollars
  • The original cost basis of the digital asset sold, which includes the purchase price plus any applicable fees or additional costs

You must report these details accurately to comply with tax regulations. In line with IRS guidelines, you must use Form 8949 to list each transaction and to showcase the capital gain or loss from your digital asset trade. This information can then be transferred to Schedule D of your tax return.

NFTs and taxation

Non-Fungible Tokens are unique digital assets that certify ownership or authenticity of items like digital art, music, or other collectibles. Unlike cryptocurrencies, each NFT is unique and cannot be exchanged on a one-to-one basis as with traditional currencies. However, for tax purposes, the IRS treats NFTs similarly to other properties. This means that they are subject to capital gains and losses just like cryptocurrencies.

When you sell an NFT, if it has appreciated in value since its purchase, you will face capital gains taxes. If it’s sold for less than the purchase price, you can claim a capital loss. You calculate these gains or losses by determining the difference between what you paid for the NFT (its cost basis) and your selling price.

A key distinction for NFTs arises if they qualify as collectibles under section 408(m) of the Internal Revenue Code due to their associated rights or assets. If an NFT is held for more than one year and is classified as a collectible, the sale could attract a higher capital gains tax rate, capped at 28%. This contrasts with the maximum long-term capital gains rate of 20% for other digital assets.

For compliance, you’ll follow the same steps as with cryptocurrencies: use Form 8949 to detail each transaction. Transferring this information to Schedule D of your tax return. By keeping precise records and understanding the nature of each asset, you can navigate the tax implications effectively.

Emerging technologies and tax compliance

Emerging technologies such as blockchain, artificial intelligence, and decentralized finance (DeFi) are rapidly transforming industries and are certainly reshaping tax compliance.

Blockchain is the technology behind cryptocurrencies and NFTs. While it introduces a newly chartered level of transparency and security, it is not without complications. With blockchain, every transaction is recorded on a public ledger. This enables easy verification of financial activities, making it harder to conceal transactions. Ultimately safeguarding the IRS. However, the complexity of these transactions can also make tax reporting even more complicated. It requires a deeper understanding of how these technologies work.

Decentralized finance extends this complexity further. DeFi platforms allow for financial activities like lending, borrowing, and earning interest without traditional banks. While this can streamline operations and potentially reduce costs, it also introduces a myriad of unchartered tax implications and major risks. This is because DeFi platforms might not subscribe to the rules set by financial authorities that prevent illegal activities like money laundering. Thus, they may lack the necessary checks to ensure that the money moving through them is not from illegal sources. Weak security measures on these platforms can also make them targets for hackers, who can break in and steal money, further complicating compliance and risk management. 

Compliance challenges in a digital environment

As digital currencies like cryptocurrencies and NFTs become more integrated into the global economy, regulatory frameworks are evolving rapidly. This is to ensure proper management and taxation. For this reason every business that dabbles in digital assets needs highly efficient record-keeping and reporting systems. These must be capable of accurately capturing every detail of digital asset transactions, including dates, values, and types of assets, to maintain compliance and avoid penalties.

Governments and regulatory bodies worldwide continue to intensify their efforts to close loopholes and mitigate regulatory risk. The U.S. Department of the Treasury is prioritizing preventing misuse by illicit actors and addressing vulnerabilities in DeFi services that expose it to laundering and cybersecurity risks.

Anticipated trends suggest tighter and more standardized global regulations to address the cross-border nature of digital transactions. To navigate these evolving tax landscapes, you can benefit from staying informed on the latest IRS guidelines and consulting a CPA that specializes in digital assets.

Partner with us for compliance

While regulation may be in motion when it comes to digital assets, accounting best practices are not.

At Fusion CPA, we have helped both individuals and businesses navigate complex capital gains submissions. We stay abreast of tax laws and offer our clients essential education on digital asset taxation. It is our goal to empower you to understand the implications of your financial portfolio. We help you submit compliant and strategic tax submissions. Contact us for assistance. 

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This blog article is not intended to be the rendering of legal, accounting, tax advice, or other professional services. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.