How To Pay Tax On Cryptocurrencies
Cryptocurrency taxes are complex because they have been classified as property for federal income tax purposes. Secondly, they are classified as currency for certain state rules such as sales and capital gains taxes.
In many countries, cryptocurrencies are taxable. Every country has its own set of rules, so double-check with a tax professional before deciding. Youll need to take into account your capital gains and losses when calculating your taxes.
In conjunction with other enforcement authorities, the IRS frequently works alongside cryptocurrency exchanges to trace crypto transactions. If you try to elude tax payments, you may face financial penalties as well as jail time or even more severe treatment.
Do I Need To Report Cryptocurrency On My Us Tax Return
Yes. If you have made a profit from cryptocurrency while you were living in the US, you will have to declare this income.
In short, cryptocurrency is treated as property by the IRS.
That means any profit you make on it will be subject to Capital Gains Tax at 30% and must be included on your 1040-NR tax return.
If you dispose of your investment for a loss, you will not need to pay tax. However, as a nonresident, you will not be able to use your losses against any tax liabilities in future years.
While the lines may seem slightly blurred in regards to cryptocurrency and tax filing now, this will unlikely be the case in future years.
Crispian Robinson, Strategic Partnerships at Koinly, says that cryptocurrency is high on the agenda of tax authorities globally:
Its clear that Tax Authorities around the world are increasingly applying pressure on the Crypto Industry in order to drive tax compliance, ranging from partnering with exchanges to gain user trading data to developing new legislation bills.
For example, President Bidens latest $1 trillion infrastructure bill has specifically singled out tighter tax regulation over the Crypto industry as a key source of funding, expecting to raise $28 billion over 10 years as a direct result.
It appears inevitable that tighter regulation and tax compliance is coming and will be key in helping to further legitimize the cryptocurrency industry in the eyes of regulators.
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If You Dont Report Your Crypto Taxes You Run The Risk Of Being Audited By The Irs
Failure to report any of the taxable events will likely result in an Internal Revenue Service audit. For the first time this year, the IRS has placed a question at the top of Form 1040 that asks t any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?
So, if youve done any of the above taxable crypto activities, its in your best interest to answer that question honestly and report your taxes on the proper forms. It should be noted that more and more exchanges are starting to report crypto activities to the IRS through From 1099-B, which means the IRS is already aware of some of your activities.
Get Started With Cryptocurrency Tax Software
Thereâs no need to fill out your tax forms by hand. Today, more than 100,000 cryptocurrency investors use CryptoTrader.Tax to file their tax return in minutes.
With a few clicks, you can select each exchange you’ve used and import all of your historical transactions.
Disclaimer – This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA, or tax attorney on how you should treat the taxation of digital currencies.
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If You Sell Or Spend Cryptocurrency
If you mine, buy, or receive cryptocurrency and eventually sell or spend it, you have a capital gain or loss just as you would if you sold shares of stock. This is where cryptocurrency taxes can get complicated.
For example, let’s say you receive $200 worth of the cryptocurrency Litecoin in exchange for services on January 15. Six months later, on July 15, the fair market value of your Litecoin has increased to $400, and you use it to buy plane tickets for a vacation. On your tax return for that year, you should report $200 of ordinary income for the payment of Litecoin in January and a short-term capital gain of $200. That’s the $400 value of your Litecoin when you purchased the plane tickets, minus your $200 basis when you received the Litecoin.
Those two cryptocurrency transactions are easy enough to track. But imagine you purchase $1,000 worth of Litecoin, load it onto a cryptocurrency debit card, and spend it over several months on coffee, groceries, lunches, and more. If, like most taxpayers, you think of cryptocurrency as a cash alternative and you aren’t keeping track of capital gains and losses for each of these transactions, it can be tough to unravel at year-end.
How To Pay Taxes On Cryptocurrency
When your crypto gains are taxed, your cryptocurrency tax rate will be either your income tax rate or lower capital gains rates, depending on how long you held the crypto. Your holding period dictates whether you pay income tax rates or capital gains tax rates.
Your crypto tax rate is dependent on your income and holding periods. If you hold the crypto for a year or less before selling it, exchanging it, or spending it, then your gains are short term and taxed at your income tax rate.
If you hold the crypto for more than a year, you are taxed at the lower capital gains rate, which changes depending on your federal income tax bracket.
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Can You Pay Your Taxes With Cryptocurrency
You might be wondering if you can pay your tax bill with digital coinage. At the time of this article, you cannot. In fact, you cant use any foreign currency to pay taxes. But thats likely to change in the near future.
The Peoples Bank of China has already rolled out a digital version of the Yuan, and the U.S. Federal Reserve is actively working on a U.S. Digital Dollar. Until then, Uncle Sam will only accept U.S. dollar payments, though you can pay him with cash, check, or credit card.
Consequences Of Not Reporting
Filing crypto tax may be complicated, but there are specific steps you can take to ensure that its done correctly. Not filing may result in serious fines from the IRS, as well as your assets being seized or a lien put on your bank account if you owe money.
Its critical to talk with an expert tax accountant before implementing any cryptocurrency-related tax approach, especially since this is a new area of taxation law. Failing to file can make you get in trouble with government authorities. You may get fees, penalties, interest, seized refunds, audits, and even jail time.
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Futures / Contracts / Options Trading With Crypto
In futures trading, you are not actually buying or selling any crypto. Instead you are speculating on the rise or fall of the price of a crypto asset in the future. When the future arrives you will either make a profit or a loss .
There is no guidance from the IRS on how this Pnl should be taxed but there are 2 possible tax categories that this can fall into:
- Capital gains tax: The profits and losses could be declared as a capital gain on your tax reports. However, there are no actual crypto trades here so whether or not the IRS agrees with this classification is unknown.
- Income tax: This is usually more conservative, you simply declare the final Pnl as income. If you end up with a complete loss then you may only be able to deduct up to $3000 from your income . Profits are taxed at your regular income tax bracket.
Note: If you are using Koinly to calculate your taxes then you can control how the Pnl is taxed on the Settings page.
Can I Use Turbotax Or Another App To Help Me Sort This Out
Yes. TurboTax, H& R Block and some other online tax platforms will lead you through the filing process for these kinds of transactions. If your platform of choice doesn’t support crypto, you should be able to use whatever system it has in place for reporting capital gains or losses related to stocks as a substitute. Note that there are also specialized tools available, like Bitcoin.tax, that can offer more specialized support for some of the more niche cases like mining.
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Which Crypto Tax Accounting Method Is Best For You
Even though LIFO and HIFO can help you shield yourself from paying hefty taxes, FIFO is the most common method among taxpayers.
It must also be noted that if you intend to use the LIFO or the HIFO method for gains calculations, you have to keep a detailed record of all your transactions. Only then you can calculate the gains in a hassle-free manner.
This was all about calculating your capital gains, but what if you incur losses? Letâs explore tax losses and how harvesting those losses can help you minimize your tax obligations.
Booking Losses In Crypto Deals
While a majority of 2017 saw high valuations for cryptocoins, there are participants who bought at sky-high prices and ended up booking losses.
As with the tax laws for other capital assets such as securities traded on the stock market, cryptocurrency losses can be used to offset capital gains, subject to certain rules, and up to $3,000 in losses that are not used to offset gains can be deducted from other kinds of income. Tax rules allow for losses to be carry-forwarded to future years.
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If Your Bitcoin Is Stolen Tough
Being robbed is bad enough, and previously if youd been swindled of your bitcoins, you might have been able to deduct it as a theft loss on your taxes. However, the new tax rules do away with the deduction for personal theft losses.
Another tax rule doesnt look favorable for owners of digital currency, either. The IRS allows owners to trade many kinds of property for a similar kind of property without immediately incurring a tax liability its called a like-kind exchange.
Before the tax law changes, bitcoin owners wanted to know whether they could engage in like-kind transactions with other cryptocurrencies. The answer was unclear, Harris says. What was unclear was whether one crypto was like-kind to another. Now the new tax reform has limited like-kind exchanges to real property, not personal goods.
Cryptocurrencies Are Intangible Property
The IRS does not consider cryptocurrencies to be currencies at all. Instead, cryptocurrencies are considered to be intangible property. In 2014, the IRS issued guidance indicating that while virtual currency operates like real currency and functions as a medium of exchange, it has no legal tender status in any jurisdiction. The IRS thus deems cryptocurrency to be a capital asset, treated as intangible personal property for tax purposes.In the past, some cryptocurrency investors utilized what looked to be a loophole for like-kind exchanges.
Those familiar with real estate investing and even homeowners may be aware that the IRS allows you to use the proceeds from the sale of a property to purchase another like-kind property without triggering a taxable event, even if you realized a gain on the 1st property. The specific section of the Internal Revenue Code in question is Section 1031, which was amended under the Tax Cuts and Jobs Act of 2017, and now only applies to exchanges of real property, meaning real estate within the U.S., and not to exchanges of personal or intangible property. Going forward, cryptocurrencies are not eligible for like-kind exchange tax treatment.
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Warning Letters Sent By The Irs For Cryptocurrency Investors And Bitcoin Investors
On July 26, 2019, the IRS announced that it was sending education letters to more than 10,000 cryptocurrency investors. It sent three versions of the letter: Letter 6173, Letter 6174 and Letter 6174-A. According to the IRS, all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors.
If you have received Letter 6173, Letter 6174 or Letter 6174-A, this means that the IRS has identified you as a cryptocurrency investor who may have failed to meet your federal tax obligations in one or more prior years. This is most likely the result of Coinbase turning over more than 13,000 investors data to the IRS pursuant to a summons and court order. In order to protect yourself, you must respond to the letter appropriately, as failing to do so could lead to a tax audit or criminal tax law investigation.
What do we mean by responding appropriately? Your filing obligations will depend on your personal tax filing history and your history of Bitcoin and other cryptocurrency transactions. If you have met your reporting and payment obligations, then you may not need to file an amended return. However, if you have failed to disclose any taxable cryptocurrency transactions to the IRS, you will need to work with Boston tax lawyer Kevin E. Thorn. He can review your returns from prior years, prepare the necessary amended returns, and determine whether any back taxes, interest and penalties are owed.
Bitcoin As Specified Foreign Property
The CRA views bitcoin as specified foreign property under Section 233.3 of the Income Tax Act. Often, people make the mistake of thinking foreign property only refers to real estate, but the CRAs definition includes many other types of assets.
Funds in foreign bank accounts, shares of foreign corporations, interests in foreign mutual funds, land and buildings outside of Canada, life insurance issued by a foreign issuer, and even precious metals held outside of Canada all carry the foreign property classification. As such, the CRA now considers bitcoin part of this category.
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Your Cryptocurrency Taxes Depend On How Long Youve Held Crypto
Your cryptocurrency tax bill depends on how long youve held it and your overall annual income.
- Short-term capital gains. If you held Bitcoin or Ethereum for one year or less, any profits would be considered short-term capital gains, taxed at your regular income tax rate.
- Long-term capital gains. Profits earned on cryptocurrency held for one year or more are taxed as long-term capital gains, generally at a lower rate than most income taxes, depending on your annual income.
If you earn cryptocurrency by mining it, or receive it as a promotion or as payment for goods or services, it counts as part of your regular taxable income. You owe tax on the entire value of the crypto on the day you received it, at your regular income tax rate.
And if you hold the same cryptocurrency you mined or earned from these activities, its value increases, and you either spend it or sell later at a profit, you would also owe capital gains taxes on the profits, based on how long youve held it.
Calculate Taxes On Cryptocurrency
As mentioned, buying and storing crypto is not a tax-triggering event. However, if someone paid you in crypto during the tax year, you mined crypto, or you bought or sold crypto, you will need to report that when you file your taxes. Receiving payment in cryptocurrency or mining crypto will need to be reported as income in terms of its fair market value in U.S. dollars. Liquidating crypto, even to purchase a different form of crypto, will need to be reported in terms of capital gainsthe cost basis being the difference between its value when acquired and its value when it was sold.
Virtual currency transactions also need to be reported, and they are taxed at the capital gains tax rate . As you can see, it can get a bit tricky to keep track of the cryptos value and calculate its cost basis every time you make a transaction or sell it for fiat currency. A good software will help you keep track of this and integrate with your accounting software, or at least provide detailed records when you turn them over to your tax professional.
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Crypto Taxes Made Happy
Crypto Taxes Made Happy: The Definitive How-To Guide For Preparing Cryptocurrency Tax Returns In The United States
This is a great book for crypto traders and investors. Its written by author, entrepreneur, and CryptoTaxPrep.com founder Mario Costanz. The book details the ins and outs of crypto taxation, the basics, taxable and nontaxable events, and what it takes to file your taxes.
Throughout the book, Mario also details crypto strategies that will help you minimize your liability. If you want to learn how the IRS treats crypto, the updates, and all you need to be a good citizen by paying your crypto taxes, this book will do just that for you.