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It may not be welcome news, but Bitcoin profits are taxable in many places around the world. And those profits have been plentiful, with its price increasing more than ten times since the beginning of the year.

Back in August, The Street warned of heightened probes into cryptocurrency tax evasion and the importance of Bitcoin investors declaring profits. Cryptocurrencies are under scrutiny like never before.

The Internal Revenue Service (IRS) recently won a lawsuit against Coinbase, one of the largest Bitcoin wallet and exchanges, requiring it to hand over records relating to users who conducted Bitcoin trades worth more than $20,000 dating from 2013 to 2015.

The taxman is set to collect taxes from 14,355 accounts, which have accounted for nearly nine million transactions. Coinbase boasts nearly six million customers, but according to a government filing, fewer than 1,000 US citizens have reported cryptocurrency holdings on their taxes. 

So what do Bitcoin investors need to be aware of?

Record-keeping is important. Investors must keep track of all their transactions. Taxpayers will need to know the exact price at which they purchased and sold a given Bitcoin or fraction and specifically identify which Bitcoin was used for each transaction.

New York-based Perry Woodin is the creator of Node40 Balance, a software platform that allows Bitcoin and Dash users to report their capital gains and losses to the IRS via a pre-approved Form 8949. Here, Woodin answers some important tax-related questions about bitcoin:

How important it is for Crypto investors to set some aside some money for taxes?

If you are investing in cryptocurrency, you really have to set aside money to pay your tax liability. It would be foolhardy to attempt to hide your gains from a regulatory agency like the IRS. We already know the IRS has been analyzing transactions on the Bitcoin blockchain since 2015. And their battle with Coinbase shows just how serious they are about cracking down on non-compliance. Around this time next year, I think we'll see numerous stories about the IRS going after individuals who have shirked their tax responsibility.

How can investors manage this issue?

Cryptocurrency investors really need to treat their assets in the same manner that they would any other investment. For starters, that means keeping accurate records. Equally important is transacting from a wallet where you own the private keys. Doing so ensures that every transaction you participate in is actually taking place on the blockchain. Investors who rely on reporting from exchanges like Coinbase could be in for a rude awakening when they realize their transactions may not have actually taken place on the blockchain, but rather on the wallet provider's company ledger.

Roughly what percentage of profits should be set aside?

Depending on your tax jurisdiction, most transactions using assets that have been carried for less than 12 months will be considered ordinary income. I strongly encourage cryptocurrency investors to reach out to their accountant for assistance in determining their tax bracket and appropriate withholdings.

What software is out there to assist Crypto investors to keep on top of taxes?

Aside from NODE40 Balance, there aren't many options for accurately managing and calculating your liability. What NODE40 realized early on is you can't apply traditional accounting principles ex post facto. In other words, the blockchain adheres to a very specific set of rules. You can't arbitrarily assign FIFO (First In First Out) or LIFO (Last In First Out) to transactions after they have already occurred. To take advantage of tax strategies, you need to apply accounting principles at the time of the transaction. Then, you need a service like NODE40 Balance to analyze the blockchain and assign gains or losses to every input involved in a transaction. Be wary of accountants or services that ask you what tax strategy you want to apply to your cryptocurrency accounting. You need to use a company that has the expertise to deliver unambiguous and correct calculations that can be used to determine your tax liability.

Israel announced it would ease taxes on cryptocurrency transactions. What does this mean for the market?

It is interesting to see Israel loosen up the reporting requirements for transacting with cryptocurrencies. This is a sign that more regulatory agencies are starting to understand how the blockchain works. These agencies are starting to realize that an open distributed ledger is a positive advancement for regulation in the financial world.

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