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In over a decade, Cryptocurrency has completely redefined the way currencies operate by making them truly global & independent, void of control by any authority.Early & savvy investors in crypto have made fortunes over the past few years! And many experts believe that this is just the beginning, Cryptocurrency is here to stay and prevail over all traditional currencies.Those who remain invested in will reap the rewards eventually.
In recent years due to the increase in the popularity of cryptocurrencies, there has been an exponential increase in the trading volumes, which has triggered tax authorities worldwide to take action.People worldwide are concerned due to the ambiguity surrounding crypto taxation laws.In the US, the IRS has been proactive in implementing taxes on Cryto taxes.
Despite the IRS’s best efforts, crypto holders are still blind about ‘when & how much they have to pay in tax.
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This article will briefly discuss all aspects of taxation on Cryptocurrency applicable to crypto traders, crypto miners, and sending/receiving payments in Cryptocurrency.Further, we’ll also briefly discuss how much crypto tax you’ll have to pay and how to classify them in your tax returns.Who is required to pay taxes on Cryptocurrency?
If you are receiving or sending Cryptocurrency, you are most likely liable for taxes.Before we delve into an in-depth evaluation of different tax incidences, let’s check in on the fundamental principle that fuels the tax law worldwide.
As a rule of thumb, any profit/net income earned is subject to tax.Most tax authorities worldwide, even the IRS, collect taxes on illegal income.
So it doesn’t matter how and what you earn; if you have made income in the year, you’ll have to pay taxes on that unless specifically exempted by law or intricately planned for tax savings by a tax consultant.For our purposes, we’ll just be focusing on two types of taxes which will define the underlying incidence of tax –
Capital Gains Tax : The sale of capital assets attracts capital gains tax.
In the US, crypto is treated as a capital asset.Therefore any sale of crypto would incur capital gains tax if the asset appreciates and sells/trade/use it for profit.If the asset depreciates and you sell/trade/use it at a loss, you may be able to deduct the losses against other capital gains to reduce your taxes.Put, if you bought 1 BTC for $800 & later sold it for $1,000, then you are subject to capital gains tax on the $200 profits earned.
Income Tax: Any income earned is subject to tax unless it satisfies a few conditions.
This applies irrespective of the type of consideration received, .i.e.if you receive cryptocurrencies as consideration for your services/sales, it will also be included at the time of computing of Gross Income.
Although the taxation laws surrounding crypto transactions are still not very well understood and adopted by the tax authorities, there is a fundamental impetus to levy a tax on any earnings, including crypto earnings.And at this point, all the taxation laws and rules related to Cryptocurrency are adapted from existing laws.Challenges arise due to the complexity and different nature of transactions in Cryptocurrency.
If you have been involved in cryptocurrency transaction in any of the following ways, then chances are you have a tax reporting requirement:
1.Trading of Cryptocurrency – If you are involved in the purchase and sale of Cryptocurrency to earn a profit, you will be liable to pay Capital gains taxes on your profit made on your trades.It could result in business income for regular crypto-traders depending on the frequency of transactions.
2.Cryptocurrency accepted as payment in lieu of sales/services – Many business owners receive Cryptocurrency in consideration for their sales and services.
Sales will be recorded at the Cryptocurrency’s fair market value at the time of receipt of payment.This sale, after adjustments, will be chargeable to income tax.It becomes tricky here; the cryptocurrencies received from customers will again become taxable when the currency is exchanged for fiat currency or another cryptocurrency at a profit.Capital gains tax will be charged on a difference between the value on the day of receipt of the Cryptocurrency and sale/exchange (it gets a bit complicated here!).
3.
Mining Income – Mining activity creates two crypto taxable events.First, Cryptocurrency generated from mining activities will be classified as self-employment income.
Miners can itemize their expenses, and the net amount will be added to their total revenue.Secondly, at the time of sale of Cryptocurrency, capital gains tax will be attracted to the difference between the value on the day of generation of the Cryptocurrency and the day of sale/exchange.
Crypto miners will have to report their income from mining in either Schedule A or Schedule C of Form 1040, depending on whether mining is a hobby or is a business.Key Points – Capital Gains on Cryptocurrency are chargeable ONLY when it is SOLD and at a GAIN.Cryptocurrency is treated as a capital asset by the IRS.
(https://www.irs.gov/pub/irs-drop/n-14-21.pdf) Earnings from the mining of Cryptocurrency are taxable as income.And any expense incurred to earn that income can be deducted as a legitimate expense.Any transaction in Cryptocurrency, which leads to gain, will be taxable.Suppose you received Cryptocurrency as payment, salary, or gift/donation.In that case, this income should be reported just like any other income you receive.Cryptocurrency received as a gift is subject to Gift tax if it exceeds the exemption limit.Refer Form 709( https://www.irs.gov/pub/irs-pdf/f709.pdf) Cryptocurrency received in lieu of salary from an employer has to be reported in Form 1040.
Similarly, the employer will have to report the salary paid in W2.(https://www.irs.gov/pub/irs-pdf/f1040.pdf)
Instances where no tax incidence is attracted in a cryptocurrency transaction- Investing/Buying Cryptocurrency with fiat currency ($) will not attract tax liability.But gain on subsequent sale will attract capital gains tax.Gifting Cryptocurrency to anyone (Within the gift exemption limit specified by IRS, For 2019 the limit is $15,000) Transferring Cryptocurrency from one wallet that you own to another wallet.How much tax to pay on crypto transactions
Tax on Capital Gains
At the time of sale, capital gains are computed based on the difference between the crypto sale price and its adjusted basis (Adjusted Basis = Cost – transaction fees).Ascertaining Cost basis has been a subject of controversy for many years.
Due to the lack of guidance on the subject, tax experts are inclined to work with assumptions.The FIFO method will be most likely prescribed as the IRS Cost basis method in the future.FIFO means First In First Out, .i.e.the first crypto assets you purchased will also be the first you sold or exchanged.
Now the tax rate applicable to your capital gains is determined based on the period the asset was held.If crypto-currency is held for a year or less, it is considered short-term capital gains.Gains will be added to your income, and you will be taxed at rates applicable to your income slab; this could vary from 10% to 37%.
These rates are subject to changes yearly.(https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2019)
If crypto-currency is held for more than a year, they are considered long-term capital gains.
Gains will be taxed at rates ranging from 0-20%, depending on the ordinary income earned during the year.Holding capital assets for more than a year is always preferred as it offers better tax savings.
If you earned any capital gains during the year, you will report the Gains in Form 1040, Schedule D & mention all the individual assets sold in Form 8949 (https://www.irs.gov/pub/irs-pdf/f8949.pdf).Please reach out to me or consult a tax expert to help you reduce your taxes!
Similar to how gains are subject to capital gains tax, any capital loss incurred can be used to set-off your taxable income.Any lowering of taxable income using capital losses will be reported in Form 1040 and Schedule D.
Tax on Crypto Miners
If you have mined Cryptocurrency during the year, then you are subject to tax.The computation and filing method will vary significantly based on the mining activity classification, either as a hobby or business venture.
Incidence of Miners who treat it as a business
Characteristics of a crypto mining business are that they generate business income, incurs business expenses like rent, electricity, software, depreciation of mining hardware, owns or leases mining equipment.More importantly, earns more than $400 from mining and reports mining income as self-employed.
Self-employment income from mining is reported in Schedule C (https://www.irs.gov/pub/irs-pdf/f1040sc.pdf).The net income after allowable expenses is reported in Form 1040.
Miners are also subject to a self-employment tax of 15.3%, reported in Schedule SE.Net loss from mining income can be used to reduce taxable income.
Incidence of Miners who treat it as a Hobby
A hobbyist refers to an individual who doesn’t consider the mining as a business/trade and doesn’t earn more than $400 .
Any losses incurred by such miners cannot be utilized to reduce taxable income.
Mining income will be reported in Form 1040.Schedule A.Miners can either claim the standard deduction or itemize their deductions subject to certain limits specified by the IRS.
Transactions where crypto tokens are exchanged for other crypto tokens
A capital gain or loss on the exchange of cryptocurrencies is calculated based on the difference between the fair market value in USD of the crypto asset on the day you exchange it and the asset’s adjusted basis when it is exchanged.
Before January 1, 2018, it was possible not to pay taxes on any Cryptocurrency exchange earnings.Starting January 1, 2018, such exchanges incur taxes.Earlier taxpayers could exploit a loophole by which capital gains on crypto-to-crypto trades can be delayed by classifying the trades as like-kind exchanges under Internal Revenue Code (IRC) section 1031, whereby they can defer income to the replacement position’s cost basis, thereby resulting in nil capital gains.But this loophole was mooted with the emergence of the Tax Cuts & Jobs Act of 2017.
Earlier it was possible to argue that cryptocurrencies could classify as the like-kind exchange category but starting from January 1, 2018, the Tax Cuts & Jobs Act specifically limited like-kind exchanges to real property, thereby eliminating any ambiguity on considering Cryptocurrency to like-kind property.
For entrepreneurs and businesses with diverse portfolios, taxes have always been a nightmare, but this has been exacerbated by a lack of tax laws and guidance regarding Cryptocurrencies.Over the past few months, IRS has intensified efforts to collect taxes from crypto users who have primarily unreported crypto earnings.Many crypto exchanges have been forced by the tax/legal authorities to disclose crypto holders’ information with holdings above a certain threshold.
As someone who has seen the evolution of tax laws to cover loopholes, I am sure that in the future, IRS will have legal mechanisms in place which will force crypto exchanges to share information with the government.I would highly recommend starting reporting your gains from Cryptocurrency, your tax consultants might be able to get your tax obligation reduced/eliminated in the early stages; this might become difficult once the tax laws mature.
Reach out to me if you need help/advice with your taxes.
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Source: https://www.thecoinrepublic.com/2021/03/29/crypto-taxes-101-everything-you-need-to-know/.