Digital assets could increase your audit or tax controversy risks

On Behalf of | Apr 6, 2022 | Tax Planning

Complying with tax law means paying an appropriate amount of income tax based on what you earn. The Internal Revenue Service (IRS) taxes everything from your wages to capital gains on investments. You may make payments from each paycheck or send in estimated quarterly tax payments. In either scenario, you have to file an annual tax return to reconcile what you paid with what you actually owe.

People are constantly searching for ways to reduce their tax obligations while still technically complying with the law. For years, offshore banks offered a financial haven, but international treaties have made made such practices virtually obsolete.

Some people have moved in two different kinds of investment because they think there will be less tax implications. Digital assets have historically been hard to locate and track, which is one reason many people find them so attractive. However, the IRS is well aware of both cryptocurrency trading platforms and the rise of non-fungible tokens (NFTs) as popular virtual assets. If you own, generate or transfer digital assets, you may have to pay taxes on those transactions.

What is the IRS approach to digital assets?

For several years, the IRS has demanded that consumers report cryptocurrency holdings and any income derived from trading cryptocurrency or mining/generating it. The IRS has specific guidelines for those investing in cryptocurrency or using it to pay for transactions.

Although the IRS has not yet released formal guidelines regarding the sale or transfer of NFTs, there is every reason that they will eventually produce specific guidance on these increasingly popular assets. In the meantime, individuals who profit from the creation or sale of NFTs may need to report and pay tax on those digital belongings. Some experts advise their clients treat NFTs as collectibles, a category of property subject to relatively high tax rates.

The IRS might find unclaimed and unreported property

Some people who fail to report their cryptocurrency earnings and NFT profits will escape the notice of the IRS and potentially avoid any consequences for their financial misconduct. However, anyone who fails to report and pay income taxes on digital asset runs the risk of enforcement efforts.

Keeping up-to-date on tax law can reduce your risk of an audit or prepare for one once you receive a letter from the IRS.