8 Things You Should Know About Cryptocurrency Taxes
Are you a cryptocurrency investor?
Have you experienced huge profits or losses from the spikes in crypto prices?
Whether celebrating the profits or mourning the losses, you’ve probably come to terms with the volatile nature of cryptocurrency prices.
Since 2009 when Bitcoin came into existence, the world has been eagerly waiting for it to replace fiat money.
But with the kind of instability it shows in prices, that may not be happening any time soon.
One thing that can however happen very soon, is you finding yourself on the wrong side of the law.
The IRS is not waiting for fiat money to be replaced before charging you taxes. It is already demanding that you pay up what you owe.
If you are like many Americans, you probably don’t know that you’re supposed to be paying taxes on your coins.
Or maybe you know about it but like many others, aren’t sure how to go about it.
We have written this for you. A brief guide on what to keep in mind when transacting using your crypto coins.
QUICK FACTS ABOUT CRYPTOCURRENCY TAXES
The IRS has provided some guidelines to be followed for tax filing purposes.
However, it’s important to note that those guidelines may not be fully comprehensive.
This is because the crypto world is still an innovation on the move.
The basics are all done. The blockchain technology is well established and is even being utilized in established institutions like banks. These are called private blockchain.
But cryptocurrencies are looking to replace fiat money as the primary medium of exchange. For that reason, there is still more that has to be achieved.
Some of the pending issues revolve around security, privacy and regulation.
Focusing on taxation, here are 8 things to help you quickly get a grasp of crypto taxes.
1. Cryptocurrency is treated as property, not currency.
This can be a bit confusing.
Well, you may think so. And certainly you’re right—at east to some degree.
The IRS however sees it slightly differently.
For tax purposes, your crypto collection is an asset. More specifically, it is property.
This becomes clear when you consider how crypto transactions are done.
If you go through the transactions step by step, you will see how the IRS came to this conclusion.
What happens when you invest in cryptocurrencies?
As an investor, you buy the coins of your choice and hold on to them for a while.
This may be several days, weeks, months or even years. It all depends on the investment period you decide to hold.
But as a typical investment, what happens to the price of the coins you have?
It is either going up or down.
If you bought a home for selling after a year or two, what would happen to its price?
It would either go up or down.
See the connection?
This is the very idea behind your investment. You buy so you can sell later at a profit. In some cases, you may experience a loss.
Either way, it is the nature of any form of property you invest in. And this is how the IRS sees it.
The appreciation and depreciation in value of coins is what makes them be considered as property.
2. You’re only taxed for selling crypto, not buying.
If cryptocurrency is property, then what transactions get taxed?
It might be comforting to know that you will not be taxed for buying cryptocurrencies. As good as that is, it is not however a move by the IRS to be lenient with you.
This is informed by the above principle that cryptocurrency is property.
When you buy property, you are basically making an acquisition. You do not stand to make any benefit. If you did, then you would be taxed for it.
Think of it this way: when you spend, you are kind of losing, but when you gain, you are increasing your wealth. That gain which you’re making is what taxation targets.
Consider the purchase of a physical product.
Phone purchase example
When you buy a new phone, you have given part of your wealth to someone else. The retailer is the one gaining because he is making a profit. He is gaining from the transaction. As such, he is taxed for that.
You, on the other hand, paid a higher price due to taxation but aren’t directly taxed for the purchase. You will not be filing any taxes for the purchase. The retailer is the one who will be doing that.
The same principle applies when buying cryptocurrency.
The acquisition is not necessarily a gain because a gain can only be achieved after a sale.
The cryptocurrency exchange from where you buy your coins is the one which will be expected to file for taxes.
Breaking down a cryptocurrency sale
To better understand this, let’s look at the step-by-step process of a coin sale. Comparing it to a purchase, you see why the sale is what is taxed and not the purchase.
To begin with, keep in mind that the IRS deals with US dollars. It does not deal with cryptocurrencies directly.
For that reason, the acquisition of US dollars is what grabs its attention.
Coffee buying example
Want to buy coffee from a restaurant which accepts cryptocurrencies for payment? Just note that you will be liable to taxation if you pay using your coins.
Believe it or not, you are gaining from the purchase of the coffee.
Here’s how the transaction happens.
Although you are only buying coffee, you are actually making two different transactions. And this is where some people get confused.
The first transaction is the selling of your coins for an equivalent value of US dollars. The second transaction is using the USD to purchase coffee.
You will be taxed for the first transaction while the shop gets taxed for the second. You stand to gain from the first transaction while the shop stands to gain from the second.
You see, in the first transaction, you increase your wealth by gaining US dollars.
This is money you did not have. You sold your coins so as to get the cash.
Whether you get a profit from this particular sale or not, it’s a transaction which you’ll have to consider when filing your taxes.
Another way of looking at it is by going back to the aspect of cryptocurrency being property.
Therefore, as you sell your coin property, remember that there are taxes waiting to be filed.
3. Payment from employer or client is taxable income.
But if you thought that not being warmly embraced makes cryptocurrencies a tax-free option for your salary, then this is for you.
The government hasn’t fully embraced cryptocurrencies due to their decentralized nature.
More than that, cryptocurrencies aim at avoiding central control—even doing away with it completely.
This is not an easy thing for governments to allow.
However, that doesn’t mean you can make extra dollars by not being taxed the same way your colleagues are. Just as they are taxed on their income, so will you.
If your employer decides to pay you using any of the cryptocurrencies, he is supposed to withhold the appropriate income tax.
If you are working for a cryptocurrency company, you might be receiving your income in the form of cryptocurrencies. Such companies may be exchanges, analysts, advisors etc.
In this case, just as though you were being paid in USD, your income is taxable. So you should file your taxes accordingly.
4. Payment from mining is taxable income.
Are you a cryptocurrency miner? Wondering if you are tax exempt?
Wonder no more. The IRS made sure they caught you when they cast their net. As you will see by the time you finish reading this article, the net was cast really far and wide.
It is obvious that crypto mining is an income-generating activity. In fact, to be fair, it is a serious venture.
Setting up a crypto mining environment is akin to setting up a factory. The kind that uses up a lot of electricity.
Take a look at the below chart showing the energy consumption of Bitcoin mining. The coin’s mining has been estimated to cost more power than that of 12 US states.
The states are Alaska, Hawaii, Idaho, Maine, Montana, New Hampshire, New Mexico, North Dakota, Rhode Island, South Dakota, Vermont and Wyoming.
Is it a wonder then that a government may want to tax an activity which uses up such amounts of power?
Keep in mind that there is need to generate and supply more power. Population growth also adds to this need.
With that kind of power consumption, the needs for a mining rig are totally different from those of a normal computer user.
Mining takes several forms and all of them are deemed taxable income.
1. When mining your own coins – if you are a miner, congratulations and all the best. For your heavy investment, we hope you get the returns you expect. Since you get your rewards in the form of the coins your platform produces, you should pay taxes on their value.
2. When mining for an employer – if you are employed as a miner, you most likely get paid in the crypto whose platform you are working in.
Your employer may even be paying you using a different coin. For example, you might be mining Litecoin but getting paid in Ethereum. Or vice versa.
Either way, the cryptocurrency in which you receive your payment is taxable.
3. When mining for a third party – if you are doing it for someone else but not as an employee, your pay is still taxable. Essentially, you are a contractor and the person you’re mining for is your client.
When you get paid, the same rules for income tax apply.
Check out the below video to see what a mining environment looks like.
5. Tax reporting is done in US dollars.
All the tax reporting you will do for your crypto transactions is done in US dollars.
There is no way, at least not yet as of now, that the IRS will use cryptocurrency values for taxation purposes.
The volatility is too high for dependability in value.
How do you know what value to use when filing for taxes?
Because of the high volatility, this is a major issue for many who are filing taxes. The answer is quite simple though—in theory. In practice, it can prove a nightmare. Especially if you have many transactions.
You determine the right value for taxation by considering the USD value at the time of the transaction.
If you’re reading this and you’ve never done any transactions, then you’re fortunate. All you have to do is keep a record of every transaction you do.
If the receipts you receive don’t show you the USD rate, then just note it yourself then keep the receipts.
Here is an example of a receipt showing the exchange rate. This is from an Athena Bitcoin ATM.
If the merchant’s receipt has the rate, then your work has been made easier. Keep it safe.
If you are reading this and have been transacting for some time, then you have to remember as many transactions as possible.
If they are many, you may not remember them all. Just do your best and the IRS will be okay with that. At least that’s all you can do for now.
Moving forward, the laws and requirements might be changing to better cover all grounds. Also, while in search of your transaction details, you can check with your exchange.
They might be able to help you track down some transactions.
With the transaction dates, you can easily check the history of the coins versus the USD and update your records.
6. Non-filing or wrongful filing can result in penalties.
As at now, the IRS doesn’t have a real way of nabbing tax evaders who make use of cryptocurrencies.
But that should not make you sit easy thinking you can live without them knowing about your income sources.
The IRS should have records of users who had bought, sold, sent, or received more than $20,000 per year between 2013 and 2015.
As you think of tax filing, keep in mind that it’s not a guarantee the IRS can’t find you out.
Filing your taxes wrongly can also cause problems. It can be seen as intentional. Non-filing on the other hand is definitely intentional. Can you escape a charge against such?
A conviction can bring about a 5-year jail term and or a maximum of $250,000 in penalties.
Therefore, it is important to cultivate the habit of filing your taxes just as though you were being paid in fiat money.
This way, when the noose gets tightened, you will have nothing to worry about.
7. Giving cryptocurrencies as a gift isn’t taxable.
Are you feeling generous? Or are you always philanthropic?
There is good news for you. You don’t need to reduce your level of giving.
Whether you are giving to charity or to individuals like friend or family, giving in crypto is tax-free.
Whatever you give in crypto form is not going to be taxed. And this is not a relief to you only. The receiver of the gift, the donee, if it’s a donation, will also not be taxed.
This is one of the exceptions the IRS provides to facilitate smooth flow of property between people. There is a caveat though.
There is a maximum amount which you should stay within if giving tax free.
Every year, the IRS determines this maximum so as to give direction to those wishing to make donations. As long as you are within this limit, you are good to go. Any gift above it requires you to file a gift tax return.
For 2019, that limit is $15,000.
8. Crypto-crypto exchange is taxable.
What about when you merely exchange one coin for another?
For example, you may be having Ethereum coins but want Bitcoin. You are not making any sale of your coins but just exchanging them for another type. Should this be taxed?
Remember the coffee buying example we looked at? A similar thing is happening here.
If you are exchanging one coin for another, there are two transactions taking place.
You are first of all selling your coin then buying another using the proceeds of the sale. Whether you make a gain or a loss on the sale is something else. But the fact is that you first sell, then buy.
On the basis of that sale, you will have to pay tax.
You will need to check the amount received from the sale and compare it to the cost basis.
The cost basis is the amount you spent to acquire the crypto you just sold.
If you have made a profit, then you file for capital gains. If a loss, then capital losses.
One thing that stands out in all of these is that cryptocurrencies are treated as property.
In fact, remembering that alone can help you remember all other things which need to be kept in mind.
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