If you've been trading or mining cryptocurrency, the Internal Revenue Service is about to come knocking.
The IRS on Friday announced that it's sending letters to more than 10,000 taxpayers with virtual currency transactions who have potentially failed to report income and pay taxes owed.
Filers who did not properly report their crypto transactions to the IRS can also expect a letter.
"Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties," said IRS commissioner Charles Rettig in a statement.
Here's the lowdown on the tax implications of cryptocurrency.
Different tax treatments
If you sold your cryptocurrency, you need to report the transaction. If you wound up with a capital gain, you must pay the appropriate tax.
Cryptocurrency you receive from an employer is subject to federal income tax withholding, FICA tax and federal unemployment taxes, just like wages. These should be reported on your Form W-2, the IRS said.
Meanwhile, independent contractors who are paid in virtual currency must pay self-employment taxes.
Finally, if you're mining cryptocurrency, the fair market value of it as of the day of receipt is included in your gross income, according to IRS guidance.
Failure to properly report these transactions can be costly: You may be audited and held liable for penalties and interest.
In the most extreme cases, you could face prison time and a fine of up to $250,000.
Chasing cost basis
Reporting taxes is easier said than done.
That's because to calculate the taxes you owe, you'll need your cost basis — that is, the original value of the asset for tax purposes. This information can be hard to find.
"If you trade out of positions, it's going to be hard to track that," said Tyrone Ross, an investment advisor in Woodbridge, New Jersey, who specializes in cryptocurrency.
"Many clients don't know their cost basis," he said.
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If you need to hunt down the cost basis of some long-held stocks and your brokerage firm doesn't have that information, you could dig up historical prices and dividend payments to figure it out.
The process is less straightforward with cryptocurrency, which any investor can trade on multiple platforms — and the exchange price can differ across platforms.
Indeed, some providers, such as Lumina and Bitcoin.Tax, have stepped up to aggregate crypto transactions and help calculate cost basis.
"What you're starting to see now is that the government has caught on," said Ross. "They realize this isn't going away and people won't be able to skirt the system anymore."