Crypto Investment: Tax Implications And You

Investing in cryptocurrencies like Bitcoin can have tax implications, depending on how and when you acquired and disposed of them. The IRS treats cryptocurrencies as property, so you may have to pay capital gains taxes on any profits you make from selling or using them to pay for goods and services. The amount of tax you pay depends on how long you've held the cryptocurrency and your total income for the year. It's important to keep detailed records of your transactions and consult with a tax professional to ensure you're complying with the relevant regulations.

Capital gains taxes

There are a few ways in which you can dispose of your cryptocurrency in the US that will result in capital gains taxes:

• Selling crypto for fiat currency
• Trading crypto for crypto (including stable coins, tokens, etc.)
• Spending crypto on goods or services

It is important to note that the tax basis of Bitcoin, or the cost at which the digital currency was obtained, becomes more complicated as less straightforward transactions occur. For example, if you receive airdropped tokens or tokens in exchange for a service at no cost, the tax basis of the airdropped digital currencies would be their fair market value at the time of acquisition.

Income taxes

Investing in cryptocurrency has tax implications, and it's important to understand how your crypto activity might affect your income taxes. In the U.S., the Internal Revenue Service (IRS) treats cryptocurrency as a digital asset, similar to stocks, bonds, and other capital assets. The money you gain from crypto is generally taxed as capital gains or income, depending on how you acquired it and how long you held it.

• Buying and holding crypto is not a taxable event. Taxes are typically incurred when you sell your crypto or use it to make a purchase, and the gains are "realized."
• If you receive cryptocurrency as income, such as from mining, staking, or getting paid by an employer, it is generally taxed as ordinary income according to your income tax bracket.
• Exchanging cryptocurrency for goods or services is taxable. The fair market value of the cryptocurrency at the time of the transaction is considered ordinary income.
• If you receive cryptocurrency as a gift, you generally won't incur a tax until you sell it or engage in another taxable activity.
• Cryptocurrency donations to qualified tax-exempt charities or non-profits may be tax-deductible.
• Transferring cryptocurrency between wallets you own is not a taxable event.
• The tax rate on cryptocurrency gains depends on your income tax bracket and how long you held the crypto before selling or disposing of it. Short-term capital gains (holding for one year or less) are taxed at a higher rate than long-term capital gains (holding for more than one year).
• Cryptocurrency losses can be used to offset gains and may provide tax benefits.
• Cryptocurrency exchanges are required to report income of more than a certain threshold to the IRS, and you must also report your crypto transactions on your tax return.

Tax deductions

The IRS considers cryptocurrencies to be property, and capital gains and losses need to be reported on Schedule D and Form 8949 if necessary. However, not all crypto transactions are taxable. For example, buying digital assets with cash, transferring them between wallets or accounts that you control, and gifting cryptocurrency are generally not considered taxable events.

On the other hand, selling digital assets for cash, trading one type of digital asset for another, using crypto as payment, and mining or staking crypto are all taxable events.

If you sell or spend cryptocurrency, you have a capital transaction resulting in a gain or loss, just like you would if you sold shares of stock. Each time you dispose of cryptocurrency, you are making a capital transaction that needs to be reported on your tax return.

For example, let's say you receive $200 worth of the cryptocurrency Litecoin in exchange for services. Six months later, the fair market value of your Litecoin has increased to $500, and you use it to buy plane tickets. In this case, you should report $200 of ordinary income for receiving the Litecoin and a short-term capital gain of $300.

If you instead sold the same $1,000 worth of Bitcoin for $800, you would recognize a loss that can offset other gains and up to $3,000 of your taxable income if your total losses are greater than your total gains. Any unused loss can be carried forward to future years.

Cryptocurrency mining refers to solving cryptographic hash functions to validate and add cryptocurrency transactions to a blockchain. If you earn cryptocurrency by mining it, it's considered taxable income and might be reported on Form 1099-NEC at the fair market value of the cryptocurrency on the day you received it.

If you receive cryptocurrency as payment for goods or services, it counts as taxable income, just as if you'd been paid via cash, check, credit card, or digital wallet. For tax reporting, the dollar value that you receive is equal to the fair market value of the cryptocurrency on the day and time you received it.

Cryptocurrency donations are treated similarly to cash donations and are tax-deductible. You can deduct the fair market value of your cryptocurrency at the time of charitable contribution, and you don't have to pay capital gains taxes when you donate.

The IRS has provided specific guidance on transactions involving digital assets that should be included in a tax return. These include the sale of a digital asset for fiat, exchanging a digital asset for property, goods, or services, and receiving a digital asset as payment for goods or services.

Crypto Tax Software

Crypto tax software helps you track all of your transactions, ensuring you have a complete list of activities to report when it comes time to prepare your taxes. The software integrates with various virtual currency brokers, digital wallets, and other crypto platforms to import cryptocurrency transactions into your online tax software.

Depending on the crypto tax software, the transaction reporting may resemble documentation you could file with your return on Form 8949, or it can be formatted to be easily imported into tax preparation software.

Tax evasion

Crypto and Tax Evasion

The IRS classifies virtual currencies like Bitcoin and Ethereum as property, and they are subject to capital gains taxes. However, the relative anonymity of cryptocurrencies and the lack of clear reporting requirements have made crypto an attractive prospect for tax evaders.

How Crypto Enables Tax Evasion

According to tax experts, the IRS may not be able to trace crypto income or transactions if they go unreported. This means that the income may not be taxed. As Jon Feldhammer, a former IRS senior litigator, explains, "Any time you create a path of non-reporting, you create a way to benefit from tax fraud in an untraceable or a much harder-to-trace way."

Additionally, crypto is not subject to the same reporting requirements as cash. For example, a business that receives over $10,000 in cash from a customer must file a currency transaction report, but the same rule does not apply to crypto. This discrepancy allows for the potential underreporting of income.

The IRS Crackdown

The IRS has taken steps to address the issue of crypto tax evasion. In 2020, the IRS began including a question about cryptocurrency transactions on its Form 1040. Crypto brokers must now track and report transactions to the IRS. The IRS has also gained information about crypto users by issuing subpoenas to popular crypto exchanges.

Penalties for Tax Evasion

Defenses Against Tax Evasion Charges

Individuals charged with tax evasion may have several defenses available. If the crypto user lost their password or access to their account, or if their earnings were stolen, they may be able to argue that the earnings are not taxable income. Additionally, genuine mistakes or an inability to pay taxes due to financial hardship may not meet the criminal threshold for prosecution.

Tax planning

Crypto investors should always keep tax planning in mind. Here are some key points to consider:

Reporting Requirements

Crypto trading and investing can lead to a variety of tax form requirements. When a taxpayer disposes of crypto holdings by trading, exchanging, or selling, these transactions and the associated profits/losses need to be reported on Form 1040, Schedule D. If there are discrepancies between Form 1099-B (sent by exchanges and trading platforms) and Schedule D, Form 8949 may need to be filed. The IRS is actively seeking more information from taxpayers by asking about crypto activity on page 1 of Form 1040. NFTs may be taxed at the higher collectible tax rate, or as ordinary income, rather than capital gains.

IRS Focus on Crypto

The IRS seeks to ensure all taxpayers comply with existing tax laws and cryptoassets are an area of particular focus. The Virtual Currency Compliance Campaign is set to continue and potentially increase enforcement actions after an initial review showed that 75% of US taxpayers were non-compliant with crypto reporting. The IRS has also identified hundreds of possible FBAR non-filers with crypto accounts, with an average balance of $1.4 million. The agency is set to maintain and increase crypto compliance efforts.

Tax on Crypto Transactions

The IRS classifies virtual currencies as property, so they are subject to capital gains taxes. However, you only owe taxes when those gains are realized, i.e., when you sell or exchange your crypto for goods or services. If you owned the crypto for more than a year, you will pay a long-term capital gains tax rate on your profit, which is determined by your income. For single filers, the capital gains tax rate is 0% if you earn up to $40,000 per year, 15% if you earn up to $441,450, and 20% if you make more. If you owned the crypto for less than a year, the taxes you pay will be the same as your regular income tax rate.

Tax on Mining and Staking

Cryptocurrency mining is considered a taxable event. If you receive crypto as payment for goods or services, or from mining, staking, or interest-bearing accounts, it is considered ordinary or non-investment income and is taxed at your normal income tax rate.

Tax on Gifts and Donations

Crypto is considered a gift if it was given for free and wasn't a payment, loan, or interest. Crypto donations are tax-deductible for donors, and recipients owe gift taxes. Gifts worth less than a certain amount ($17,000 in 2023 and $18,000 in 2024) don't carry federal tax implications and don't need to be reported. Donations made in crypto can be deducted from gross income to lower taxable income.

• Crypto contributions are set to increase, with many institutions now allowing individuals to make contributions in cryptoassets. However, since cryptoassets are not universally considered readily valued property, for contributions worth over $500, taxpayers must complete and file Form 8283. For donations exceeding $5,000, taxpayers need to undergo an appraisal that fulfills IRS requirements or forgo the charitable contribution.
• Discuss cryptocurrency taxes with a financial advisor to minimize tax liabilities and avoid potential consequences from tax authorities.
• Be aware that quarterly estimated taxes must be filed if you expect to owe more than $1,000 in crypto taxes on your annual federal tax return.
• Crypto exchanges are legally required to report account activity on customers who gained at least $600 on their trades every year. Exchanges send Form 1099-B, Form 1099-K, and Form 1099-MISC to both the IRS and the customer at the end of the tax year.
• Crypto investors tend to deal with various cost bases due to market volatility and fluctuating transaction fees. It's important to keep a log of transactions to determine how a transaction will be taxed.

Frequently asked questions