If you happen to be one of them, you must be aware that you owe some taxes to the government.
If you are not, this article is just the right one for you. In this article, you will come to know whether or not you owe taxes for crypto trading and if so, then how much.
You will also come to know how it works, the rules that are applicable, the things to include in your tax report as well as the consequences of failing to do so.
Yes, crypto activities do impact your taxes but the problem is most people are not aware of it.
You are required to report your crypto sales and conversions, the payments made and a lot of things to the IRS or Internal Revenue Service.
Failing to comply with the rules applicable may result in some dire consequences.
Therefore, go through this article minutely to know about the different implications of taxes so that you are ready with your report along with all supporting documents well ahead of time and avoid penalties.
As it is, tax is a complicated subject and it needs a lot of knowledge about the current rules and following the news.
Therefore, the IRS treats crypto as any other capital assets like stocks and bonds.
It is taxed at different rates depending on whether your activity is considered as an income or capital gain.
This is determined on the basis of how you obtained the crypto asset or assets and how long you held on to them.
Is It Required to Pay Taxes on Crypto Profits?
Whether you buy Bitcoin when the price is low and hold it till the price rises or buy some Ethereum and sell it off to make some quick profits, either way all your crypto activities are subject to taxes and will impact your tax bill. Period.
Ideally, it is very important to know how you use your crypto in the first place in order to know whether or not you will be taxed for crypto.
There are specific methods used by the tax department to determine whether a transaction is to be considered as a taxable event or a non-taxable event.
The following are considered to be non-taxable events:
- Purchasing crypto coins with cash and holding it instead of selling them and realizing the gains
- Donating cryptocurrencies to a qualified non-profit organization or a tax-exempt charity
- Receiving a gift in the form of a crypto asset unless you sell it, stake it or participate in any other taxable activities
- Giving a gift in the form of crypto to others up to $15,000 per recipient in a year or transferring an amount not for purchasing goods or services and
- Transferring crypto from your wallet to the crypto account you own.
On the other hand, the following crypto activities will be considered as a taxable event or capital gains by the IRS:
- Selling your crypto holdings for cash that is worth more than what you paid to buy those coins
- Converting one crypto coin to another because it means you are selling one asset to buy another new asset provided the selling amount is more than the purchase amount and
- Spending crypto coins to buy goods and services since it is nothing different from selling digital assets.
Apart from that, the IRS also has got a specific set of parameters to determine whether your crypto activity will be taxed as income. These are:
- If you get pain in crypto coins from your employer
- If you receive crypto coins in lieu of goods or services
- If you mine crypto coins it will be considered as self-employment income and taxed on the fair market value of the mined tokens
- If you earn staking rewards which is deemed as mining proceeds and taxed similarly
- If you earn crypto in any other way such as holding specific crypto coins
- If you receive new crypto coins as a hard fork depending on how you use it later on when you withdraw them and
- If you receive an airdrop from the crypto company as their promotional offer or a giveaway.
The IRS may also consider your income as taxable if you receive any other type of rewards or incentive related to crypto that may include but not limited to a referral program endorsed by the crypto exchange, any bonus or offer made by them, and more.
There is one significant aspect to keep in mind at this point, which is, a taxable event is different from gains and your taxes will be charged accordingly.
For example, as said above, a taxable event is when you realize gains or losses when you sell crypto for cash, convert one crypto to another, or buy a good or service in exchange for it.
The gains are however a continuous event which you realize till the time you own and hold the original shares.
Therefore, make sure that you first determine whether or not your crypto activity involves any one of these types mentioned above and prepare your tax file accordingly to report them all in detail to the IRS.
Understanding Crypto Taxes
If you want to understand crypto taxes in a much better way than what is said till now, you should understand how the IRS or Internal Revenue Service defines virtual currency in the first place.
According to the IRS Notice 2014-21, in the United States virtual currencies are considered as property.
This means that anything you buy using crypto coins will be taxed according to the law involving capital gains and the amount will depend on how long you hold onto them.
It is the duty of the crypto traders and investors to disclose everything in the tax file and report about them to the IRS or face charges for tax evasion.
It is advised that you go through the IRS Notice 2014-21 issued by the IRS as well as the IRB 2014-16 which provide enough guidance to both individuals and businesses regarding crypto taxes, taxable events, and tax treatments of any transaction that involves crypto coins.
In addition to that, you can also go through the Frequently Asked Questions on Virtual Currency Transactions for individuals published by the IRS for that matter.
All these will make you more knowledgeable about crypto taxes whether you hold your coins as a capital asset or engaged in trading your coins.
This will also save you from violating the law and at the same time know how capital gains taxes work.
Remember, the tax rates as well as the income limits are subject to change every year and therefore it is required by you to stay up to date.
Usually, it depends on your filing status. Therefore, be informed and educated always.
How Does It Work?
Crypto tax works just like selling or buying any other stocks but there are some additional aspects involved in it that makes its working process a bit difficult to understand for any average user.
In order to make it work in your favor, you will need to follow the right process to file your crypto taxes.
Ideally, you will need to answer a question in the Form 1040 which is whether or not you have indulged in any form of crypto transaction in the past.
It can be any type of engagement such as selling, buying, exchanging, staking, or mining crypto coins.
If your answer is ‘Yes,’ then you will need to keep a few things in mind while following the tax filing process such as:
Keep all records of all your crypto transactions properly including the amount paid, time you held the coins, the amount you sold them for, and the receipts for every transaction.
Remember, even if the crypto exchange provides a 1099 B to report your crypto taxes to the IRS, it may not include the cost basis.
Therefore, make sure you include all details in your crypto transaction records.
Next, you must fill out all the necessary tax forms correctly.
However, the type of forms needed to submit will depend on how exactly you used your crypto. For example:
- Form 8949 – It includes every sale and purchase along with the number of coins, the dates, the price, and your loss or gain.
- Schedule D – This includes your total capital loss or gains from all your investments including crypto.
- Schedule C – If you mine crypto you will need to state whether it is your business or a hobby. If it is your business you will need this form if your income is more than the expenses and you will then owe self-employment taxes.
- Schedule 1 – If crypto mining is your hobby you will need to mention it on Line 8 of this form. You will not owe self-employment tax but then what you can deduct as expense will be limited.
Now, you should file your overall state and federal tax returns with or without using online tax software.
Expert tip: It is always better to hire an expert professional to prepare crypto taxes.
They will not only help you with the intricacies and nuances involved in it but will also suggest ways in which you can minimize your tax amount.
Deciding Tax Percentage
The tax percentage you need to pay will depend majorly on how long you hold your crypto coins.
For example, if you hold them for more than 36 months from the date of purchase or receiving them, it will be deemed as long-term capital gain and will be taxed up to 20%.
The amount will also include the surcharges as applicable. Few countries may also add cess to it after indexation.
Therefore, it is advised that you check it out with the tax department of your country before you finalize on the taxable amount on your crypto activities.
Tax Consequences for Capital Gains and Crypto Mining
If you make capital gains on your crypto transaction, you will need to pay taxes at the rate of any ordinary taxes.
The amount however will depend on your income and the term you held onto your coins.
The rate can be anywhere from 0% to 20% for long term capital gains and more than 30% for short term capital gains.
Once again, you are advised to check it out with the tax department of your country.
Crypto miners are however treated differently by the IRS. If it is your business then your mining activity and profit will be taxed just as any typical business.
In this case the value will be the revenue produced and your expenses can be deducted but everything will be done at the fair market value.
However, it is not the case if crypto mining is your hobby.
According to the tax rules, you will not be exempted from paying taxes on your crypto activities just because you did not get a 1099 just as you get in the case when you deal with a bank or brokerage.
In fact, since November 2021, the law needs everyone moving or dealing with digital assets to follow greater tax reporting even if one does not have any access to info.
Though this law is being refined currently, the fact remains that you cannot escape crypto taxes due to non-availability of form 1099.
There is also a new set of rules imposed by the Biden government in the 2022 budget proposal regarding reporting crypto taxes by the users. It includes:
- Businesses to report any crypto transaction worth more than $10,000
- Crypto custodians and exchanges to furnish data of those user accounts that has gross inflows and outflows of crypto worth $600 in any given year and
- Increasing the tax rate on long-term capital gains from 23.8% to 43.4%.
All these are applicable on all transactions made on or after April 28, 2020.
Determining the Amount Owed
Therefore, now you know that some of your crypto activities are taxable.
Now the question that may do rounds in your mind is: how much do you actually owe in crypto taxes?
Well, it is a good question and there are few ways to estimate the amount you owe as taxes.
Ideally, all you have to do is calculate your gains, losses, and income, based on the parameters already mentioned in the second paragraph.
Calculating crypto income:
As said earlier, all your income from crypto in the form of staking, mining, and rewards are subject to federal and state income tax, as the case may be, and will be deducted.
The amount of tax will depend on the current income tax rate that is applicable to your particular tax bracket.
If your income is huge, you will fall in a higher tax bracket and you will have to pay higher taxes.
Calculating capital gains and losses:
When it comes to calculating capital gains and losses on crypto, you will first need to know the initial amount of crypto you had with you or in your wallet.
This will be the cost basis and it varies based on how you got the coins.
If you simply bought crypto coins, the cost basis will be determined by the amount you paid for owning the coins.
On the other hand, if you earned the crypto coins from mining or by staking them for a certain period, the cost basis will be determined on the fair market value of the coins at the time you received them.
And, if the coins were gifted to you by someone else, the cost basis will be determined according to both the cost basis of the person who gifted you the coins and the fair market value of the coins when you received them.
If you sell your crypto coins, the cost basis is deducted from the selling price in order to determine whether you made a capital gain or loss.
If it is more than the cost basis, it will be considered as a capital gain, and if not, you will have incurred a loss.
Consider the term:
Now that you know the cost basis and whether or not you have made a capital gain or loss, you will need to consider the term.
This means you will need to find out whether it is a short-term capital gain or a long-term capital gain.
Remember, capital gains taxes are applicable for both and can be changed at both the federal and state level, as applicable.
Ideally, the amount you owe as capital gains taxes will depend on how long you held onto your crypto coins.
If you held it for more than a year and then sold it, you may end up paying taxes at a much lower rate than you would have generally if you would have sold the coins right away.
This means that if you make long-term capital gains, you will be taxed at a lower capital gains rate.
These rates can be either 0%, or 15%, or 20% at the federal level. It will vary once again according to your income.
If you fall under the bracket of a higher taxpayer, you may also have to pay an additional 3.8% Net Investment Income Tax on your capital gains and other income.
However, please do look up in the government websites to know the current guidelines and tax rates since these are amended from time to time and you would surely not want to violate any of them and fall into deep trouble.
On the other hand, if you make short-term gains, it will be taxed at the standard income rate.
However, this is usually higher than the tax rate charged for long-term capital gains and therefore is less favorable.
Now, if you realize capital loss when you sell your crypto coins, it can work in your favor while calculating your taxes.
You can use these losses to offset any other capital gains that you have made during the year and this includes capital gains made via non-crypto assets such as stocks and bonds.
This is done on a dollar-for-dollar basis which potentially, and sometimes significantly, reduces the overall tax bill.
However, what if you incur losses only and little or no gains? In that case, there is a limit in the maximum amount that you can declare as losses for one year and offset your other income.
This is usually $3000, but do check the website for the latest updates.
If there is any amount left over in this year, it will be automatically carried over to the following year or years, until the entire amount of your loss is applied and done away with.
Things to Report
There are different things that you need to report in your tax return, according to the Form 1040, such as:
- Crypto sales
- Crypto purchases
- Crypto exchanges for goods and services or other crypto
- Amount of profit or loss on sale, if any, and
- Crypto donation to qualified charitable or non-profit organizations.
All your capital gains must be reported on Form 8949. Add to that, it must also be summarized on Schedule D in the tax return.
Consequences for Failing to Report
As said earlier, the crypto exchanges do not send any tax forms on behalf of their clients to the IRS.
Therefore, it is essentially required that you self-report your crypto use, holdings, and transactions.
You can however take help from a few specific crypto exchanges who may help you to generate reports that will facilitate preparing your tax returns.
Alternatively, you can use one or more of different third-party tools to help you in reporting your crypto taxes.
If, knowingly or unknowingly, you fail to report about it to the IRS, your tax file will be audited and when the discrepancies are revealed, you will be charged penalties and interests as well.
And, if it is found to be an intentional act of tax evasion it may even result in criminal prosecution.
This means that you may end up in prison for up to five years and also need to pay a fine of up to $250,000, as the case may be.
The IRS has taken up a lot of measures and implemented a lot of rules to crack down the users who do not report their crypto activities in their tax files.
If you are caught for not reporting your crypto gains or losses, you will have to pay penalties and/or other serious consequences.
You may think that it is easy to evade taxes on crypto transactions because these are anonymous. However, these are not untraceable, mind you.
The IRS has specific tools and mechanisms to crackdown on such malicious practices as a part of their Operation Hidden Treasure.
They have a Fraud Enforcement Office where the agents are trained to identify people who are fraudulently attempting to skip reporting their crypto gains.
These agents also work with private organizations to identify and crackdown such attempts made by individuals.
Apart from that, the IRS has also issued subpoena or summons to centralized crypto exchanges to gather information about the US taxpayers who are noncompliant.
Even the court has authorized the agency to issue John Doe summons to several crypto exchanges such as Circle and Kraken to find out about those crypto users who have conducted crypto transactions worth a minimum of $20,000 from 2016 to 2020.
Similar summons were also used by the IRS to Coinbase to check cryptocurrency transactions from 2013 to 2015.
Based on their findings, the IRS announced in 2019 that they would send letters to more than 10000 crypto users for noncompliance with the tax rules.
In this letter they have urged the people to review their tax files, make amendments in the past returns wherever necessary, and pay back taxes along with interest and penalties.
Therefore, there is no way in which you can evade crypto taxes because the IRS is getting smarter in this aspect and have made it very clear that it will take necessary actions for noncompliance.
They employ different new data analytic tools in-house for that matter.
For example, the IRS has partnered with TaxBit in this regard and uses software to scrutinize crypto wallets and analyze them to find out what was bought and/or sold in cryptocurrencies and identify the tax evaders.
You must always plan ahead before you get involved with crypto transactions and one good thing to do is know about the tax implications and consequences. If you did not know about it, by now you must be well aware of it, courtesy this article.