Cryptocurrency is just like any other asset class when tax season comes around. Unfortunately, cryptocurrency taxes appear so complex that few people file them. Others see cryptocurrency as a means to move money illegally, avoiding cryptocurrency taxes entirely.
As cryptocurrency becomes more mainstream and the Internal Revenue Service (IRS) shifts its focus to digital assets, it’s more important than ever to pay cryptocurrency taxes. Here’s how to approach cryptocurrency this upcoming tax season.
Is Crypto A ”currency” Or An ”asset”?
Tax experts have been contemplating classifying the cryptocurrency between ”currency” or an ”asset”. Cryptocurrency and crypto-assets are the names primarily used interchangeably.
However, classifying it as a ”currency” needs some legal backing from the government, in the absence of which it is safe to classify it as an ”asset/property”.
Since the tax implication would arise irrespective of the legality status, classifying them as ”assets” would be a better approach than any government clarification.
Further, the U.S government had also issued a notification classifying it as a ”property” and thereby levying capital gain taxes on the gain on sale of the cryptocurrencies. Know more at bitcu.co.
1. All Cryptocurrency Trades And Sales Are Taxable
You must report gains and losses on all individual trades to the IRS. Specifically, exchanging a cryptocurrency for another, converting it back to USD or spending cryptocurrency are taxable events.
2. The IRS Is Increasingly Focused On Crypto Taxes
What happens if you don’t pay cryptocurrency taxes? Like any other type of tax fraud, avoiding cryptocurrency taxes can result in a maximum sentence of five years in prison or a maximum fine of $250,000.
From 2013 to 2015, fewer than 900 people filed cryptocurrency taxes annually. But the IRS’ focus has increasingly shifted toward cryptocurrency taxes. Following a 2017 court case, Coinbase has to release information about investors who have traded over $20,000 to the IRS.
3. Two Main Types Of Cryptocurrency Taxes
According to the IRS’ Guidance on Virtual Currencies, cryptocurrency is property, not currency. This means that you have to pay capital gains tax.
There are two different types of capital gains taxes: long-term and short-term. Long-term means holding a currency for over a year before selling or trading it, while short-term applies to cryptocurrencies you’ve had for less than a year. Though long-term capital gains tax is typically lower, these rates depend on your state and tax bracket.
Crypto can also be subject to income tax. When you’re paid in cryptocurrency by an employer, your crypto is classified as earnings. You pay the same amount in crypto income tax as you would in USD. This means cryptocurrency income taxes are divided into the same seven IRS tax brackets, ranging from 10 per cent to 37 per cent. Forty-three states also have their income taxes.
Employees and employers have to report cryptocurrency earnings and withholdings, respectively, as they would with USD.
4. Crypto Taxes Typically Require Two Tax Forms
The majority of investors interested in cryptocurrency taxes are investors. Specifically, they use Sales and Other Dispositions of Capital Assets Form 8949 to report on digital trades.
The investor describes the assets they’ve traded, including the dates they acquired and sold, how much they made, the cost of making the trade, and their net gain or loss. The form also distinguishes between short-term and long-term capital gains and losses.
The second form concerning crypto trades is Form 1040 Schedule D. This one covers your total short-term and long-term gains and losses based on information from Form 8949.
5. Cryptocurrency Miners Have To Pay Taxes
Cryptocurrency miners have to pay taxes on their earnings, meaning that their cryptocurrency is subject to income taxes. Additionally, mining qualifies as self-employment. This requires a self-employment tax, which is typically around 15.3%. As self-employed, miners can also deduct expenses, such as electricity.
6. Not Everything Crypto-Related Is Taxed
Investors aren’t taxed for just buying and holding cryptocurrency. In other words, you need to sell or trade to be subject to taxes. And more broadly, capital gains taxes for crypto function as it does for other assets: If you lose money on your cryptocurrency trades, you can claim a loss and save on capital gains taxes.
7. Cryptocurrency Tokens Are Potentially Tax-Exempt
The IRS last updated its guidance on cryptocurrency taxes in 2014. Since then, a lot has changed in the cryptocurrency space. Specifically, there is speculation that tokens—a cryptocurrency representing a service or asset, not a currency—are not subject to federal tax laws. This is because the IRS defines taxable crypto as “virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency.” Tokens can theoretically fall outside of this definition.
However, consult with a certified accountant or lawyer before deciding what you choose to include or exclude from your cryptocurrency taxes.
Cryptocurrency Tax Checklist
Cryptocurrency investors have a lot of information to compile. Here’s what the typical crypto investor needs to do:
- Determine whether they’re a trader, an employee paid in cryptocurrency or a crypto miner
- Create a complete list of all trades for that taxable year, including the following information. All these amounts must be calculated in USD based on the exchange rate at the time of the trade:
- Trade date
- How much it was paid for
- How much it was sold for
- The cost of making the trade
- The net gain or loss
- Complete appropriate forms, most likely 8949 and 1040 Schedule D, or submit the necessary information to an accountant.
Cryptocurrency Taxes Are Still In Flux
Paying cryptocurrency taxes is just like paying any other type of capital gains or income tax, except for one significant factor: It’s generally up to the investor to compile the information themselves. This means going through hundreds or thousands of trades, recording the necessary data, and planning to do it again next year.
Additionally, there is a lot we don’t know about the nitty-gritty of cryptocurrency taxes yet. For example, the IRS’ status on cryptocurrency airdrops and tokens remains unclear.