Diving into digital currency taxation
Taxes are not the first thing that most individuals/investors consider when jumping into the world of cryptocurrencies. However, the IRS continues to crack down on cryptocurrency tax compliance and it’s important to learn how cryptocurrency is taxed.
In the US, cryptocurrencies like Bitcoin are treated as property for tax purposes. Just like other forms of property such as stocks, bonds and real estate, you incur capital gains and capital losses on cryptocurrency investments when you sell, trade or dispose of your cryptocurrency. The tax rates fluctuate depending on your personal tax bracket and are decided on whether the gains fall under short-term (less than 12 months) or long-term (12 months or more).
So, when do you owe taxes on your cryptocurrency? You trigger a tax reporting requirement whenever you incur a taxable event from your crypto- investing activity. A taxable event simply refers to a scenario where you realize income. The following are all considered taxable events for cryptocurrency:
- Trading crypto to fiat currency like the US dollar.
- Trading one crypto for another cryptocurrency.
- Spending crypto to purchase goods or services.
- Earning crypto as income.
There are also circumstances in which you do not owe taxes on your cryptocurrency, such as whenever you: a) buy and hold crypto; or b) transfer crypto from one wallet you own to another wallet you own. In order to calculate your capital gains and losses from each of your crypto sells, trades or disposals, you can simply apply the following formula:
Fair market value (FMV) – cost basis = capital gain/loss.
Now that you know how to calculate the tax liability, how should you go about reporting cryptocurrency on your taxes? This income is considered capital gains income and should be reported as such. However, if you earned cryptocurrency as a form of payment from a job, mining, staking or earning interest rewards, that earned income will be treated as ordinary income. (To report your capital gains and losses, you will need to file IRS Form 8949. Be sure to list all your cryptocurrency trades, disposals and sells. And make sure to include the date you acquired, sold/traded, along with the fair market value, your cost basis and your gain/loss for the event.
Unfortunately, when it comes to ordinary income, the process is not as simple. There are specific situations in which a different tax form must be used. If you earned crypto as a business entity, you would report your earnings on Schedule C. If your income is derived from staking income or interest rewards from lending out cryptocurrency, this should be reported on Schedule B. If you were to treat your cryptocurrency events as a hobby, a Schedule 1 would be used to report as other income. If you are mining as a hobby, any income derived from it would be subject to Capital Gains Tax as mentioned before.
The cryptocurrency market is fast and wild. The world of crypto is forever changing from the viewpoint of not only the taxpayers but even the IRS.
For more information or further guidance, call 618.997-3436 or visit taxplanning.com.
Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. Please visit taxplanning.com for more information on succession planning and other business concerns.