Alas, death and taxes are also certainties in the world of cryptocurrency. Hopefully your crypto portfolio doesn’t contain any coins that died, but in certain situations, you will still have to pay taxes on digital currencies like Bitcoin, Ethereum, and Dogecoin.
If you’re reading this article, you probably already know what digital coins are, since you’re wondering if you need to file taxes for cryptocurrency. But, just in case you don’t know what cryptocurrency is, we’ll give a brief overview of the crypto market and why crypto earnings are taxable (according to the IRS).
For centuries, currency was made out of actual precious metals and minted at the discretion of monarchies. While ancient China was the first country to issue paper currency, the practice did not take hold in Europe until the 16th century—mostly because the Americas provided Europe with a steady stream of precious metals like gold and silver. In the colonies themselves, paper currency was often used as a substitute for actual minted coins. Eventually the idea of paper currency took hold in Europe. Precious metals were relegated to banks and other safe deposit institutions, while paper certificates tied to them acted as a sort of IOU for a more convenient way of circulating the value for goods and services.
Eventually paper currency was severed from its connection to gold, first in 1933 and then fully in 1971. In 1913, the Federal Reserve Bank was created in the U.S. as a measure to thwart market volatility (something it has arguably not succeeded in; many critics say it has created inflation). No matter how you slice it, fiat currencies (that is, paper cash and coins minted from low-value metals) are still controlled by a central authority, in our case, the US Federal Reserve. Moreover, most of the transactions we make for goods and services are managed by third parties like Visa, Mastercard, and consumer banks.
But what if there was a way to exchange currency in true peer to peer fashion, without the involvement of an issuing government or centralized bank? Enter cryptocurrency, or digital coinage. Cryptocurrency was created in 2009 by an anonymous programmer from Japan (or so it is believed) known as Satoshi Nakamoto. Nakamoto created Bitcoin, a digital coinage for P2P transactions, secured by something called blockchain—a decentralized ledger of every transaction using Bitcoin. Since Bitcoins inception, dozens of other cryptos have been invented, such as Ethereum, XRP, and Dogecoin.
While cryptocurrency is really intended to be used as money, it has primarily become known for its fluctuating value on the various crypto markets (that is, venues where cryptos can be traded for other cryptos or even fiat currency, like dollars or euros). Crypto traders buy and sell crypto as the value of a given coin goes up and down, much like stocks. Crypto miners do not delve into the earth for precious metals, but they record and verify transactions on the blockchain, which sometimes requires some complex math. In return for mining coins, these miners might receive cryptocurrency as payment.
You might be wondering why—if crypto is actually a form of currency—should it be taxable. After all, aside from property taxes, you don’t normally need to pay taxes on assets you haven’t liquidated, such as cash in a retirement account. Is crypto any different when it comes to the IRS? And if it is, what is the cryptocurrency tax rate?
The IRS views crypto as an asset and taxes it accordingly. Since crypto is regarded as an asset, that means its taxable value is based on capital gains or capital losses. If you exchange your crypto for another crypto or liquidate it for a fiat currency, your crypto will be subject to short term capital gains tax or long term capital gains tax, depending on how long you’ve held it for. A short term capital gains tax is applied to assets purchased and liquidated within less than a year, and a long term capital gains tax is applied to assets that have been held for at least one year before liquidation. Right now, any long term capital gains less than $40k are not taxed, while gains between that and $441,450 are taxed at 15 percent, and any beyond that at 20 percent. Short term capital gains taxes are significantly more punitive, with a 22 percent rate at $40,126 (for a single filer) and increasing to 37 percent for any gains over a half million.
You might think you can get around crypto taxes if you collect crypto as payment for services rendered or goods provided. If crypto is treated like an asset, shouldn’t it be tax free? After all, assets other than real property are not taxed unless they are liquidated.
As it turns out, the IRS does require you to report the fair market value in U.S. dollars of any crypto received. That means, for instance, if someone pays you a single Bitcoin as a consulting fee, and Bitcoin is priced at $36k per coin, you will need to report a $36k payment from that client when you file your taxes.
That’s not all. You will also be responsible for keeping track of the crypto’s value, so you can calculate its cost basis if you liquidate. In some cases, this might lead to being double taxed.
Before discussing how a taxpayer can meet their tax obligations on virtual currency, it would be helpful to understand what constitutes a taxable event and what does not constitute a taxable event.
Selling digital currency for fiat currency (for example, selling Bitcoin in a digital wallet for dollars) is a taxable event. Trading one crypto for another—on a cryptocurrency exchange, for instance—is a taxable event. Virtual currency received as payment for goods or services triggers taxation, as does receiving crypto in return for mining it, as well as if someone airdrops it into your digital wallet.
In regards to that last event, you might be wondering why a cryptocurrency airdrop is taxable, since gifts are subject to the gift tax exclusion. A crypto airdrop does not just refer to someone transferring files wirelessly from one device to another. Rather, a crypto airdrop is a promotional giveaway of a new digital currency to attract crypto investors to a newly released coin.
Some of the IRS’s stances toward digital currency may seem a bit punitive. Cryptocurrency is an alternative to the US Dollar, so its arguable that the government doesn’t view it very favorably. By the time you are reading this article, they U.S. Federal Reserve may have released its own digital coinage, as well as new rules and regulations in regards to a cryptocurrency tax.
In any event, some forms of cryptocurrency investment are not subject to long term capital gain taxation, short term capital gain taxation, or even ordinary income. A crypto investor using fiat currency to purchase a crypto asset, such as digital coins or fractions of digital coins, is not a taxable event. In most cases, gifting a crypto asset to a charitable organization is not a tax triggering event. Gifting crypto under $15k USD to any person is not necessarily a tax reporting obligation. Lastly, transferring a crypto asset from one digital wallet to another (both of which you own) is not taxable.
Basically, as long as you are not liquidating your cryptocurrency for fiat currency or something that could be purchased with fiat currency, you don’t need to pay taxes on it. However, that does not mean you can avoid keeping track of the value of your crypto assets, since if you do liquidate them, you will need to know the cost basis of this capital asset for tax purposes.
Now that we’ve covered which transactions are taxable, let’s talk about the steps required to file crypto taxes.
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 gains—the 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 (this certainly makes purchasing Subway with Bitcoin seem like more of a hassle). As you can see, it can get a bit tricky to keep track of the crypto’s 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.
Form 8949 for the Sales and Other Dispositions of Capital Assets will be used to report your crypto related gains and losses. There are some crypto exchanges that will issue a Form 1099-B showing your gains and losses, but not every exchange does this, so ultimately it will be up to you to keep track of the crypto’s dollar value.
There is software, like TokenTax and CoinTracker, that integrate with TurboTax to help you conduct regular accounting of your crypto activity. If an investor’s cryptocurrency assets are just one part of a diversified portfolio, this is also the form they will use to report gains and losses on other assets, like stocks, bonds, and real estate (but not rental income).
If a tax professional manages your accounting, then they will fill this form out for you. However, it’s not very difficult to find—it can be downloaded right from the IRS website. If you use accounting software to do your taxes, it’s likely that this software that will include this form.
No matter which method you use—whether it’s you or your accountant—someone should be keeping track of the dollar value of your crypto assets throughout the year.
You will pass these gains and losses on to Schedule D, which is included on the Personal Income Tax Form known as Form 1040. Form 1040 includes several other schedules (essentially added documentation) for a variety of concerns, such as Schedule C, which documents profits and losses from business activity, and Schedule E, which documents income from rental properties.
When all the schedules are factored in, the taxpayer will be able to determine the total amount of income taxes they will be paying or the tax refund they will receive.
Filing taxes will be a little different if a crypto investor operates as a different type of entity than a sole proprietor or an LLC. If, for instance, they have organized their operations under an S-Corp, they will need to file a corporate tax return (which is also due April 15th, annually).
To learn more about the most advantageous entity structures for taxes, check out the Anderson Advisor’s Tax Wise Workshop for business owners and investors!
It’s a good idea to save record of your tax filing for at least seven years, although some individuals choose to save them for longer. If you are using a software-based form of accounting, you’ll likely have the option of saving your tax returns for as long as you’d like.
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 can’t use any foreign currency to pay taxes. But that’s likely to change in the near future.
The People’s 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.
If you are buying and selling crypto, your taxes on cryptocurrency won’t really be any different than what you would pay on buying and selling stocks. The amount of taxes will be based on the cost basis of the asset and how long you’ve held on to it before liquidating. However, investors who work with stocks may have a particular advantage when it comes to trader tax status. Trader tax status allows day traders to treat their stock market trading as a business activity, granting special privileges like writing off business expenses and taking advantage of a wash sale. Crypto traders do not yet enjoy this privilege, although they may in the future.
However, crypto taxes will be more if you accept crypto payments for goods or services or mine crypto and liquidate the crypto. This is because you must report the crypto received as income, and then report its sale as a capital gain. Thankfully you can write off business expenses against the dollar value of the crypto you’ve received in payment, lowering the tax burden.
You might also be able to sell the crypto at a time when its dollar value makes it a capital loss. For example, if you received one Bitcoin in payment, valued at $36k, and deducted $6k in business expenses, you would need to report $30k of income. If for some reason you had to liquidate the Bitcoin that same year and waited until its value dipped to $30k, you would be realizing a material capital loss of $6k. You can deduct a capital loss against your income, but only up to $3k per loss. So, at the end of the day, you would be looking at $30k in taxable income and a $3k tax deduction.
As you can see, it can all get a bit tricky trying to figure out how to pay less taxes when it comes to digital currency investments.
Gifting cryptocurrency is one way to avoid being taxed on its liquidation. And even though there is such a thing as a gift tax, there is a gift tax exclusion of $15,000 per person per year. The lifetime gift tax exclusion is more than $11 million, which means that most people are not going to pay taxes on gifts, including the dollar value of crypto.
Taking note of crypto losses can also help you pay less taxes. Remember that capital losses can be deducted against your income, in addition to avoiding the capital gains tax. This strategy, called tax loss harvesting, is a classic tool used by investors to reduce their taxable income. Though specific forms of tax loss harvesting are only available to those who file day trading taxes, there is nothing that stops someone from writing off losses on their tax return.
Choosing which accounting method can also potentially reduce your tax burden. The First In First Out method (FIFO) is the default method most investors use to calculate the cost basis, using the first purchase and last sale of an asset in the calculation. Last In First Out (LIFO) is another method, using the last coin bought and first coin sold to calculate the cost basis. Though the difference may seem negligible, in the fast moving and volatile crypto market, there can be sizable price swings in seconds. If a crypto trader is buying and selling with volume, these differences can add up to thousands if not tens of thousands or hundreds of thousands of dollars. Take note however, that whatever method you select will be the one you need to stick to for all your crypto accounting.
When it comes to taxation, crypto is most often treated as an asset that becomes taxable with capital gains, and can serve as a tax write off when it yields losses. If you accept crypto as payment or mine crypto, you will need to declare its market value as income, a situation that can result in double taxation if you also liquidate the crypt.
All in all, the issue of cryptocurrency and taxation is very complex. Although cryptocurrency itself was designed to be a peer to peer mechanism of payment—not relying on the centralized authority of an issuing bank or government—individual taxpayers residing in the U.S. will have to provide notice of their crypto transactions and crypto investments, or risk being reported for tax evasion.
That’s why it is highly recommended that those with cryptocurrency investments consult with an Anderson Advisors tax professional and use bookkeeping software that keeps track of the markets. With a little preparation, filing cryptocurrency taxes will be a little less painful—as much as filing and potentially paying taxes can be anyway.
How to File Crypto Taxes
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