Everyone likes money, right? Consequently, many of us look to find any way possible to hold on to it. Crypto is no different. However, taxes on crypto can burn a hole in your pocket. Ignoring crypto tax regulations can cost you big time. This ultimate crypto tax guide covers everything you need to know about the latest laws and requirements related to filing taxes in the U.S.
The importance of understanding crypto taxes
Three things are certain in life: death, change, and taxes. You can’t change the first two but you can control the latter. You may be subject to an audit, asset seizure, and even jail time if you do not pay your taxes. Meaning the government takes your money, your property, or you.
Crypto tax guide: recent changes in US tax regulations
The U.S. regulations on crypto taxes are not very exhaustive and, in many cases, anachronistic or implicit. Much of the interpretation of the law surrounding crypto tax guidelines in the U.S. is confusing. This is because regulatory bodies often refuse to take a stance on crypto one way or another, so many interpretations are based on case law.
As a result, the most recent definitive guidelines on crypto are from as far back as 2014 through 2021. However, a few cases have set precedents in recent times. For instance, the infamous Tezos staking case — Jarrett v. United States.
Jarret v. United States
In brief, Joshua and Jessica Jarrett claimed that self-generated staking rewards could not be regarded as taxable income under federal law. They filed a lawsuit against the IRS in 2021 to recover federal income taxes imposed on the Tennessee couple.
They were offered a refund; however, they refused it on the grounds that they wanted assurance that the issue would not come up in the future. The court refused to give assurance — a reoccurring theme with U.S. crypto regulations. As a result, the case was recently rendered moot.
SEC v. Ripple
In another case, the United States Supreme Court dismissed a motion involving a law firm’s attempt to withhold records from prosecutors related to a crypto-promoting client in a tax investigation. The decision contradicted what other federal appeals courts had ruled in similar cases. Several legal organizations, including the American Bar Association, filed briefs urging the justices to adopt a more expansive standard.
According to several federal court rulings, private communications between an attorney and a client related to the provision of tax advice are legally protected. The majority of cases involving the tax attorney-client privilege involve federal evidence law. As a result, the fundamental guidelines governing the federal attorney-client privilege are not codified and are instead entirely determined by case law.
Crypto tax guide: the basics
So how are cryptocurrencies taxed in the U.S. This may come as a shock, but crypto is taxed by activities in the U.S. rather than asset type. The purpose and how the cryptocurrency is used dictates how you will file taxes on your cryptocurrency.
Definition of cryptocurrency for tax purposes
Before diving into this crypto tax guide, we must define cryptocurrency. It may seem redundant, but defining a term is important. It gives that word or phrase a specific meaning within the context of the legal document rather than the meaning that would be used in everyday speech. For example, according to Merriam-Webster’s Dictionary, a cryptocurrency is:
But according to the IRS, a cryptocurrency is defined under this description of digital assets:
Digital assets are broadly defined as any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.Internal Revenue Service
As you can see, most people define a cryptocurrency as a digital currency that is secured by cryptography and updated via distributed ledger technology. The IRS defines a cryptocurrency as digital assets secured by cryptography on a distributed ledger and anything similar. Digital assets include, but are not limited to:
- Cryptocurrency and convertible virtual currency
- Non-fungible tokens (NFTs)
How cryptocurrency is taxed in the US
The U.S. government does not consider digital assets real currency (i.e., fiat). This is because a central bank does not issue them. Therefore, for federal tax purposes, digital assets are considered property. This means the tax laws that apply to capital assets, a subset or property, also apply to crypto.
The IRS considers property such as houses, cars, rental properties, stocks, bonds, antiques, or works of art capital assets. Property that is not a capital asset includes inventory and other property held primarily for sale to customers in a trade or business. There isn’t a single, unambiguous rule that specifies how your cryptocurrency transactions will be taxed; however, the IRS has published a set of instructions.
In general, transactions involving digital assets must be reported on a tax return. Although nuanced, most cryptocurrency transactions fall under capital gains or income tax in these situations.
Crypto tax guide: capital gains and losses
Capital gains taxes are levied on profits from the sale of assets such as stocks, real estate, businesses, and other types of investments held in non-tax-advantaged accounts. When you buy and sell assets for a profit, the U.S. government considers the profits taxable. Capital gains taxes fall into two categories: short-term and long-term.
Short term gains
Your tax amount largely depends on how long you’ve owned your cryptocurrency. The IRS considers the “holding period” to begin the day you acquired the currency and end the day you sold it. A short-term gain is a profit from the sale of a capital asset, such as a piece of personal or investment property, that is owned for one year or less.
These gains are taxed at your personal income tax rate as ordinary income and vary based on the income tax bracket. Below is a guide for you to navigate your crypto tax based on your income bracket.
Federal income tax bracket for 2023 (Deadline: April 15, 2024)
Your capital gains profit is added to your income and then taxed according to the bracket you fall under.
The difference between your cost and selling price is the capital gain on which you must pay short-term tax. For example, if you purchase an assortment of cryptocurrencies for $90,000 and sell them at $100,000, you would add the $10,000 profit to your income. Let’s say you’re income is $95,000. Adding the capital gains will put you in the 24% bracket for a Single filer.
Long term gains
A long-term gain is a profit from the sale of a capital asset, such as a piece of personal or investment property, that has been owned for more than a year. You can take advantage of lower long-term tax rates on capital gains if you hold cryptocurrency for longer than a year. Below is a guide for you to navigate your crypto tax based on your capital gains.
Long-term capital gains tax bracket for 2023 (Deadline: April 15, 2024)
Consider a scenario in which you spent $10,000 on a variety of cryptocurrencies, sold them for $20,000, and received $100,000 in profit. When it comes to long-term capital gains on that transaction, you are then subject to a 15% tax rate. For a gain of $10,000 at a capital gains rate of 15%, there would be a tax liability of $1,500.
This, of course, excludes transaction fees when purchasing crypto. In most cases, incurring transaction fees may result in deductions from the sales price.
If you sell your cryptocurrency at a loss, you can claim a capital loss for the difference between the purchase and sale prices. You can also deduct lost or stolen crypto as capital losses. If your losses exceed your gains, you may deduct up to $3,000 per year from your ordinary income (e.g., W-2), interest income, and self-employment income (e.g., 1099) on your tax return.
After being applied against income, any remaining net loss is carried forward and used in subsequent years. For instance, if your capital losses exceed your capital gains by $5,000 in a given year, you can deduct $3,000 from your ordinary income. This will leave you with a $2,000 loss that is used to offset capital gains in subsequent years.
Crypto tax guide: common types of taxable events
A capital gains event is triggered whenever an individual trades or sells a cryptocurrency, whether for a profit or a loss. In cases where crypto profits are earned (compensation for services, including fees, commissions, fringe benefits, and similar items), it is considered income rather than capital gains. Here, the income tax rules apply instead.
Many activities like yield farming or liquidity providing, staking, or mining fall into the income tax category. When you add more activities, this complicates the affair. For instance, if you stake and then sell your earned rewards, you may face a double tax. This potentially triggered two taxable events, one when you staked (income tax) and two when you sold (capital gains tax).
Furthermore, when you consider crypto’s volatility, this could unintentionally trigger a taxable event. For example, stablecoins are meant to have a consistent price. But say, for instance, if you buy 10,000 stables at $1.00, and the price rises to $1.01, you have just made $100. Regardless, if the price falls back to $1, this could be considered a capital gains tax event.
Record-keeping for crypto taxes
In its current state, crypto is extremely volatile — meaning prices fluctuate uncontrollably. Understandably, this makes it extremely difficult to keep track of your net gains and losses. Nevertheless, there may be some ways for you to stay compliant.
Importance of accurate record-keeping
It is important to note that all activities in crypto may not result in a taxable event. However, if you are going to pay crypto taxes, it is important to familiarize yourself with record keeping. Not doing so is the difference between a levy and an audit. When you report efficiently, you can take advantage of tax loopholes, crypto-friendly states, or deductions.
Tools and resources for tracking crypto transactions
Your first and most powerful tools for tracking crypto transactions are right in front of you. Transaction receipts, block explorers, and crypto wallets are your first line of defense. From here on out, you want to keep a record of your transactions.
The Coinbase Ventures-backed CryptoTaxCalculator is made to produce tax reports that accountants will appreciate. Your transaction history is imported, and your report is exported. It supports more than 800 protocols and 87 chains, covers NFTs, DeFi, and DEX trading, and the best part is you can start for free.
Establishing cost basis for crypto assets
Calculating the cost basis of your cryptocurrency is the first step in figuring out how much you owe. According to US tax law, cost basis refers to the original cost of an asset after deductions for depreciation, stock splits, dividends, transaction costs, and capital returns.
Simply put, your cost basis is the purchase price plus the purchase fees. When you buy crypto from a centralized exchange, a transaction fee is paid to the exchange. You would add this price to the price you purchased the coin or token for (i.e., Cost Basis = purchase price + transaction fee).
Crypto tax guide: taxable crypto events
Now that we’ve covered how crypto is taxed, we can go over what events are taxed. There are many different and complex activities in crypto, as it is a new asset class. And more activities are emerging daily, but most fall into already-trodden territory.
Anytime you dispose of your crypto (i.e., sell, trade, transfer, or convert), it triggers a taxable event. Assets that are not disposed of are considered unrealized gains and generally not taxed. Disposed assets are called realized gains. They include:
- The sale of a digital asset for fiat
- The exchange of a digital asset for goods, services, or property
- The exchange or trade of one digital asset for another
- Receipt (e.g., liquidity provider token) of a digital asset as payment for goods and service
- Receipt or transfer of a digital asset (for free) that does not qualify as a bona fide gift
- Transferring a digital asset as a bona fide gift if the donor exceeds the annual gift exclusion amount or the recipient disposes of the gift (e.g., sell, trade, etc.)
- Bona fide gifts are not taxed
Crypto mining and staking rewards
Crypto staking is one of those gray areas where regulators have not offered a guide on how to tax it — as stated previously in Jarret v. United States. However, most tax preparers agree that crypto-staking rewards are taxed as income at the time of receipt. If you dispose of the crypto, it triggers a capital gains tax.
On the other hand, mining is clearly defined. If a taxpayer’s mining of virtual currency is a trade or business and is not done as an employee, the net earnings resulting from those activities are self-employment income and are subject to the self-employment tax.
Airdrops and hard forks
The tax burden on crypto airdrops and hard forks in the U.S. is pretty straightforward. If a blockchain undergoes a hard fork, and you receive an airdrop as a result of the hard fork, it is taxable income. Receiving an airdrop, in general, constitutes a hard fork.
Another scenario concerns testnet tokens. Ordinarily, testnet tokens have no extrinsic value. However, some developers will create ways to pay for testnet tokens to circumvent a lack of supply. This attaches a dollar amount to your testnet tokens (almost like a pseudo airdrop), which has tax implications for the holders of said token. Recently, LayerZero introduced a testnet bridge that initially set the price of Goerli-ETH to $0.10, which has tax implications for all Goerli-ETH holders.
Spending crypto and crypto payments
Spending crypto for goods or services is a taxable event subject to capital gains and losses. It is also important to note that crypto loans (and loans in general) are not taxable. However, interest received from lending crypto is considered income.
For the purposes of employment taxes, virtual currencies received as compensation (remuneration) from an employer for services rendered counts as wages or ordinary income. Also, virtual currencies received by an independent contractor for performing services constitute a self-employment tax.
Reporting crypto and crypto taxes
You need to know the different methods and tax documents to file your taxes. This will not absolve you from hiring a tax professional. However, it will save you time and money.
Relevant IRS tax forms
When you are ready to do your taxes, you will have to decide which tax forms to use. As a rule of thumb, you should consult an expert. But here are a few forms to help get you in the right state of mind to avoid confusion. Staying prepared will help you save some time — as you will likely need a lot of it, especially if you own a business or corporation. There are two types of tax forms you may need:
- The IRS 1099 Form is a group of tax documents that list various payments made by a person or company that is typically not your employer. The payer completes the form with the necessary information and mails duplicates to you and the IRS. They are typically given by exchanges.
- Some 1099’s include 1099-B (a broker or barter of exchange must fill out this form), 1099-NEC (non-employee compensation, most likely self-employment tax), 1099-MISC (payments not subject to self-employment tax, or directly to independent contractors).
- The 1099-DA is a new tax document that has not been released yet. The form deals specifically with digital assets.
- A W-2 is a tax document that your employer is required to send to you.
- You may need this one if your employer pays you in crypto.
- The 1040 is the general form used to file your individual income tax return. You will record the various types of income you earned on the 1040 form.
- Depending on the type of income you report, you may have to attach other tax forms to it.
- Used to report sales and exchanges of capital assets.
How to calculate and report gains and losses
There are a few popular methods that help you calculate your gains and losses: FIFO (first in, first out), HIFO (highest in, first out), LIFO (last in, first out). These methods determine the fair market value to calculate the income received. Depending on your situation, you may prefer one method over the others.
For example, let’s say you buy one X token for $50,000 on September 1. Then you buy another X token for $85,000 on October 1. Next, you buy one more token X on November 1 for $75,000. Lastly, you sell one token X for $90,000 on December 1. The sale price minus the cost basis equals the capital gain.
FIFO is the default method of the IRS. With FIFO, you would take $90,000 (the selling price) and subtract $50,000 (the purchase price) from the first purchase. You will have a capital gain of $40,000. This method is better to use in a bear market. It is the most common method and results in fewer capital gains.
With LIFO, you subtract $75,000 (the last price you purchased) from $90,000, the selling price. This will result in a $15,000 capital gain. This method works best in a bull market and will result in fewer capital gains.
The last method is very popular for cryptocurrencies. Here you subtract $85,000 (the highest price) from $90,000 (the sell price). This will result in a $5,000 capital gain.
Reporting requirements for specific crypto events
Whether you are an individual, you must report nearly all crypto activities. This includes, but is not limited to:
- Capital gains and losses
- Trades, conversion, or sales
- Services rendered
- Assets and liabilities
Crypto tax strategies
Before you start looking into tax loopholes, people use some methods to minimize their taxes. Do not be rash; take the time to consider your options and consult a knowledgeable tax preparer or CPA. Although, here are a few options you may want to ask them about.
One method is the wash sale. A wash sale is when a security is sold for less than it is worth and is promptly bought back after. Under the Internal Revenue Code in the United States, losses from such sales are generally not deductible.
It can be argued that because cryptocurrency is not a stock or security, according to the IRS, it is exempt from the wash sale rule. This implies that you can record a capital loss even if you sell your cryptocurrency at a loss and then buy it back within a set period of time. Remember that you also need to comply with the IRS economic substance doctrine.
Holding periods and long-term capital gains
You can also minimize your taxes through holding periods. Short-term capital gains are taxed less favorably than long-term. So if you hold onto your crypto for more than a year, you gain a favorable tax rate.
Tax implications of NFT and DeFi transactions
Depending on the situation, NFTs are taxed in different situations. For instance, if you sell an NFT, it is a capital gains tax. But if you receive an NFT as an airdrop, it may be considered income. Fractionalized NFTs may fall under the same guidelines, though no definitive code exists.
NFT staking usually falls under two interpretations. One philosophy is that when you stake your NFT with a platform, you simply deposit, not sell. Therefore ownership doesn’t change, and no taxable event has occurred (in some places). The second is that when you stake up your NFT, ownership changes hands, constituting a taxable event.
DeFi and tax
There is not a clear line of demarcation as of yet. DeFi transactions, likewise, are a little more complicated. Generally, taking out a loan is not taxable, but receiving interest on a loan is. Liquidity farming, mining, or providing are taxable as income.
Another obscure activity, as far as tax codes are concerned, is yield farming. A multitude of activities constitute yield farming. Some of these include: depositing into liquidity pools, short-term lending via yield aggregators for passive income, and payouts in receipt tokens.
One way these protocols operate is to automatically send a portion of the rewards to the wallets that contain receipt tokens. Another method is for the rewards to accumulate on the platform and be ‘claimed’ by the depositor. In the third method, the rewards increase in proportion to the amount deposited, and the receipt token represents an increasing amount of deposited funds.
When the receipt token is returned, and the deposited funds are withdrawn in this scenario, the investor receives more money than they deposited. These are all considered income events. Though, depending on the protocol, some steps in the process may or may not be tax events (e.g., lending tokens to a decentralized protocol to yield farm).
Crypto tax: audits and legal considerations
Legally, you should consider your options on how to file your taxes. As explained earlier, if you do not file, the government could seize your property, take your money, freeze your bank accounts, or send you to jail. However, a couple of steps are involved before you reach this point.
Understanding IRS audit triggers
The IRS has an algorithm that detects unusual tax returns. For example, if your W-2 tax document indicates that you earned more than you reported, it will trigger an audit. Make certain that you report all of your income to the IRS, including investment and gambling profits, large cash deposits, cash businesses, large amounts of foreign assets, and crypto.
Some of the most common audit triggers are:
- Digital assets
- Failure to report business profits and losses
- Gig work
- Cash-based businesses
- Reporting hobbies as a business
- Financial assets are hidden outside the U.S.
- Home office deductions
Responding to an audit or tax notice
Sometimes people make mistakes, and the IRS must send an audit or tax notice to clarify things. If the IRS decides to audit you, they will send a notice or letter.
It could be about a specific issue on your federal tax return or account, changes to your account, requesting additional information, or requesting payment. The notice you receive will explain why your return is being reviewed, what documents, if any, they require from you, and how you should proceed.
On the other hand, an audit is more serious. There are different types of audits. The first step is the correspondence audit. If you receive a letter from the IRS requesting documentation or proof of the statement, your account is under correspondence tax audit.
The second is the office audit. The commission may request an in-person meeting to clarify your tax data in this type of tax audit. In this case, you must go to the IRS. You will meet with an IRS auditor in person in a field audit. If you are in this situation, you should hire an IRS audit attorney.
Importance of professional tax advice
It is paramount that you seek professional tax advice from an experienced CPA or tax preparer. The right one can find deductions; the wrong one can cost you more than you should have to pay. Even the greatest investors sometimes need teams of lawyers to prepare their taxes.
In many situations, an individual’s tax documents may be the size of a phone book. This is infinitely multiplied for corporations and businesses. So you will definitely need some help.
U.S. tax codes are ambiguous
As the old saying goes, no one is bigger than the program. Do not try to cheat the system. Considering nearly all crypto investors avoided taxes in 2022, you should be prepared for government backlash. Therefore, be vigilant. This crypto tax guide explains how to practice good bookkeeping throughout the year to save time and money in the long run. Some taxes can take weeks to prepare and require teams of accountants. At the moment, preparing your taxes is admittedly intensive and confusing. U.S. tax codes are expansive, and crypto laws are ambiguous. We suggest enlisting professional help in order to navigate today’s crypto tax landscape.
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Top crypto platforms in the US | December 2023
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