The cryptocurrency market continues to grow, along with increased scrutiny from the Internal Revenue Service (IRS). As more taxpayers use virtual wallets to buy, sell, and exchange digital assets like cryptocurrency, tax professionals, must understand how these transactions create federal tax and reporting obligations.
Now more than ever, it’s essential for preparers to know how cryptocurrency is taxed, reported, and audited. In this post, we’ll cover the basics of crypto tax law, so you can confidently help clients stay compliant and avoid costly mistakes.
What is cryptocurrency?
Cryptocurrency is virtual currency that isn’t secured by a government or bank. Instead, it’s secured through cryptography and recorded on a digital ledger called a blockchain. While there are some nuances between the terms “cryptocurrency” and “digital currency,” all are “treated as virtual currency for Federal income tax purposes” by the IRS.
How is cryptocurrency taxed?
Cryptocurrency is taxed when it is sold, exchanged, or received as payment. Simply purchasing and holding virtual currency does not generally create a taxable event.
For federal tax purposes, the IRS generally treats cryptocurrency (also called digital currency or virtual currency) as property. However, two basic guidelines provide the framework for most tax situations involving crypto.
1.If the cryptocurrency was bought and sold as an investment, the IRS regards it as property, and it will be subject to short or long-term capital gains taxes.
2. If cryptocurrency was paid or received as income, it will be subject to regular income taxes.
If cryptocurrency is disposed of, such as being used to buy goods or services or exchanged for another virtual currency, it may result in a capital gain or loss that is reported on Form 8949 (sales of capital assets) and summarized on Schedule D (capital gains and losses).
If cryptocurrency is received as payment for goods or services, it is generally treated as ordinary income based on its fair market value in U.S. dollars at the time received and is commonly reported on Schedule 1 (additional income). Because many crypto transactions do not generate a Form 1099, accurate client recordkeeping and documentation is important.
When is cryptocurrency an investment?
For most people involved in crypto, it’s treated as an investment, similar to stock. If your client bought and held the currency less than a year before selling it, any profit will be taxed at the short-term capital gains rate, which is the same as the income tax rate for their tax bracket. If they held it for more than a year, they’ll pay long-term capital gains tax:
2025-2026 Tax Rates for Long-Term Capital Gains
| Filing Status | 0% | 15% | 20% |
| Single | Up to $48,350 | $48,351 – $533,400 | $533,401+ |
| Head of household | Up to $64,750 | $64,751 – $566,700 | $566,701+ |
| Married filing jointly | Up to $96,700 | $96,701 – $600,050 | $600,051+ |
| Married filing separately | Up to $48,350 | $48,351 – $300,000 | $300,001+ |
You’ll calculate capital gains or losses using Form 8949 and report them on Schedule D Capital Gains and Losses (Form 1040).
While that may sound relatively simple, in order to calculate capital gains or losses, you’ll need to know which transactions are taxable and which aren’t.
When are crypto transactions taxable?
Before calculating capital gains or losses, it’s important to identify which crypto transactions are taxable. Simply purchasing cryptocurrency and holding it does not make it taxable, neither is transferring crypto between a client’s own personal virtual wallets. However, these transfers can sometimes trigger Form 1099-B to be issued. This form is used to report proceeds from broker transactions, accurate documentation is essential to verify no sale of exchange occurred.
Crypto transactions become taxable when a client sells currency for cash or exchanges it for another cryptocurrency. Crypto to crypto exchanges are treated as a disposition of property. For each taxable event, the client must track cost basis, proceeds, and the fair market value in U.S. dollars on the transaction date to determine any capital gain or loss.
Most crypto exchanges will automatically keep records of these transactions, but if your client uses multiple platforms or personal virtual wallets, they’ll need to be more careful about keeping their own records.
When is cryptocurrency considered income?
Cryptocurrency is treated as income when it is earned or received as compensation, such as payment for services, wages, or mining rewards – not when it is later sold or exchanged. This is separate from capital gains, which apply when the cryptocurrency is later sold, exchanged, or disposed of.
The fair market value in U.S. dollars on the day it is received determines the amount that must be reported.
If an employers pays wages in cryptocurrency, those payments are treated as taxable compensation and must be reported on Form W-2. These wages are generally subject to federal tax withholding, Social Security, and Medicare taxes, just like traditional cash wages. Employers must convert the cryptocurrency’s value to U.S. dollars.
For self-employed individuals or independent contractors, digital assets received as payment is also considered taxable as income and must be reported based on its U.S. dollar value at the time received. This income is typically reported on Form 1040 through a Schedule 1 for Additional Income. Even when no tax form is issued, taxpayers are responsible for tracking and reporting all crypto compensation accurately.
They’ll report it using Form Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income, as applicable.
How are NFTs taxed?
Non-fungible tokens (NFTs) can be any type of digital item such as a piece of art, a song, a news column, a trading card, or other collectible. Their ownership is verified and tracked using the blockchain, and they are often bought and sold using cryptocurrency such as Ether. Since the IRS hasn’t issued guidance specific to NFTs, they are a point of confusion for many crypto traders and tax professionals alike. While NFTs aren’t technically cryptocurrency, they are blockchain-backed digital assets and face similar tax laws.
When they are purchased using cryptocurrency (as they almost always are), this is a taxable transaction for the buyer. The IRS regards this as converting the cryptocurrency to “real,” government-backed currency like the U.S. dollar and then using those dollars to purchase the NFT. If the currency grew in value from the time the buyer first acquired it to the time they “sold” it to buy the NFT, the purchase would result in capital gains. Similarly, if the cryptocurrency had gone down in value, the purchase of the NFT would result in a capital loss. Selling an NFT for cryptocurrency also results in a capital gain or loss.
Creators of NFTs will be subject to regular income tax for the sale of their digital items. If they create NFTs as a business, they can deduct the expense of creating and minting their NFTs. If creating NFTs is simply a hobby, however, they won’t be able to deduct the associated expenses.
What happens if you don’t report cryptocurrency on taxes?
As with any other form of taxable income or investments, it’s important that your clients accurately report their cryptocurrency transactions. If the IRS suspects noncompliance, your clients could find themselves facing a tax audit. In recent years, the IRS has expanded third-party reporting requirements for digital asset transactions.
Prior to recent IRS updates to broker reporting, some cryptocurrency exchanges issued Form 1099-B (Proceeds from Broker and Barter Exchange Transactions) to report crypto sales. However, beginning with transactions in 2025, crypto reporting is transitioning to Form 1099-DA (Digital Asset Proceeds from Broker Transactions). Any discrepancies between your clients’ tax returns and the 1099s issued by the exchanges will be an automatic red flag to the IRS.
If your clients know they have not complied in previous years, now is the time to file an amended tax return and pay and outstanding tax liabilities in orderto avoid an audit in the future.
What are the tax preparer’s responsibilities when it comes to cryptocurrency?
While there is no cryptocurrency specific due diligence rules, tax preparers should take a proactive approach in identifying and verifying crypto transactions for their clients.
Many clients may genuinely be unaware of their crypto reporting requirements, so it’s important to ask clear, direct questions during intake or interviews. Instead of assuming disclosure, guide the conversation to clarify whether the client bought, sold, exchanged, or received digital assets, and clarify whether those assets were earned as income or held as an investment.
You should review complete transaction history across all sources, including:
- Multiple exchanges
- Personal or self-custodied virtual wallets
- Payment apps or other crypto-enabled platforms
This full view will help ensure accurate cost basis, transaction reconciliation, and gain and loss calculations. From there, your TaxSlayer Pro software supports Form 8949 and Schedule D (Form 1040), making it easy for you to calculate and report capital gains or losses.
