Over the last decade, cryptocurrencies have dominated the headlines and they seem not to fade off amidst numerous myths and misconceptions. Cryptocurrencies like Bitcoin provide a viable means of payment, just like fiat currencies. However, despite the numerous benefits that cryptos have to offer, some quarters of the global economy are not happy with it. One reason for that is the wrong belief around the subject of cryptocurrencies and the underlying technology, blockchain.
One common misconception is that cryptocurrencies are nontaxable. This guide will highlight why this myth is further from the truth. We also discuss the different taxation scenarios in the crypto space.
Are cryptocurrencies taxable?
Although some countries like South Korea, Netherlands, and Liechtenstein don’t impose taxes on cryptocurrencies, others like Spain and the US have already enacted laws to regulate crypto taxation. Taxation on cryptocurrencies varies from country to country depending on how they perceive the digital assets. For example, some countries like the US, UK, and Australia tax cryptos as a capital gain. In Germany, however, cryptos are taxed based on whether you’re buying or selling.
IRS regulations on cryptocurrency taxation
When Bitcoin came into the limelight in 2009, many users saw it as a means to avoid government intrusion and evade taxes. Over the years, many governments have moved in to try and regulate the sector, although some countries like China banned it altogether. Many cryptocurrency users today see the need to comply with government regulations to continue enjoying the enormous benefits that cryptos offer over the traditional fiat currencies.
The Internal Revenue Service (IRS) classifies all cryptocurrencies as property. So, when you buy bitcoins, it is not a taxable event. But, when you use your bitcoins to purchase something, it is considered a sale of bitcoins. Any property sold at a price higher than the purchase price is considered a taxable event. So, if you sell bitcoins that you bought over the last one year at a profit over what you spent, you will have to report the short-term capital gains and pay ordinary income taxes. But, if you sell bitcoins that you have held for more than a year, you will be required to report long-term capital gains, which attracts lower rates.
What if you sell your bitcoins at a loss?
In the same manner, you will be subjected to short or long-term capital losses. The tax can be utilized to offset your capital gains. However, if you sell bitcoins within 30 days of selling bitcoins at a loss, it may generate a wash sale. If that happens, the loss is folded back into the purchase.
The IRS currently relies upon the taxpayer to accurately track and pay tax on cryptocurrencies. Even if the IRS is not aware of your crypto activities, your responsibility to comply with tax code still stands. So, if you have been trading cryptos or using cryptos to make purchases, you need to keep track of the transactions. Every purchase is considered a trade lot, which is a taxable event.
Is receiving crypto payments taxable?
When you get paid in cryptocurrency, the taxation takes a whole new approach. If the payment is for goods or services rendered, it is considered as income and you will have to pay ordinary income tax. You additionally need to pay self-employment taxes.
The whole taxation process can be confusing if you mine coins, accept crypto payments, and receive credit card rewards here and there. If you additionally use cryptos to make daily purchases of groceries or other basic items, the confusion is even more pronounced. Every single transaction is potentially a taxable event or a wash sale.
New IRS tax changes
Over the last one year, the crypto market recorded many new trading pairs than ever before. More transactions were carried out on crypto exchanges, making it critical for taxpayers to manage their records more efficiently.
To ease the process of taxation, the IRS clarified the issues of like-kind exchanges. According to the taxman, like-kind exchanges only apply to physical property like real estate. So, crypto to crypto trades are considered capital gains. The taxation does not just apply when you cash out fiat currencies like USD. The IRS guidance requires all virtual currencies to be taxed as property. So, trading Bitcoin for Ethereum is still a taxable event.
Keeping track of all these transactions and correctly filing your IRS Form 8949 can be a tedious task. However, new tools are coming up and soon it will be easy to automate the process.
Taxation of mined coins
The IRS considers mined cryptos as taxable income. The mined coins are included in your gross income and valued at fair market value on the day they were mined. The process of filing the tax will depend on the manner of mining, your expertise, and the amount of profit you made. So, business miners and hobbyist miners will be subjected to different tax regimes. Hobbyists are required to add the income to their Form 1040 and exempted from self-employment taxes. Business miners, however, must include their income and expenses on Schedule C. Their income is subject to income tax of 15.3 percent, though they can claim deductions against their income.
Once the coins are mined and you pay income tax, it is entered in your directory as a trade lot. Any subsequent gains are taxed as short term or long term capital gains.
What are the consequences of evading crypto taxes?
Many crypto traders believe that the anonymous, decentralized nature of blockchain technology and cryptocurrencies shield them from government intrusion. This is a misconception that can lead you into trouble with the authorities. While the IRS has not fully gone after crypto traders evading taxation, they are surely ramping up. Just recently, the IRS won a case against Coinbase. The suit requires the exchange to share records of individuals who own more than $20,000 worth of transactions. Whether you bought, received, or sold cryptos, your records will get to the taxman.
Blockchain is a distributed public ledger, which means that any entity can view the ledge anytime. To figure out the activities of an individual, you only need to associate a wallet address with a real-life name. In the near future, regulating authorities will be able to build software solutions that are specific to auditing blockchains. Choosing to use crypto as a means to avoid taxation is a risky decision that can expose you to tax fraud.