As the IRS continues observing crypto tax evasion, it is becoming immensely crucial to be mindful of how your cryptocurrency investment is going to be taxed. Let us help you know all about cryptocurrency tax in the United States of America. From high-end tax implications to the ultimate tax forms you are expected to fill out, you should know about ways to be compliant while reporting your taxes effectively.
Understanding Crypto Taxes
In the United States of America, cryptocurrencies like Ethereum and Bitcoin are treated as properties for taxation purposes. Just like other types of property (including real estate, stocks, and bonds), you tend to incur capital gains as well as capital losses on cryptocurrency investment while selling, trading, and disposing of the cryptocurrency.
Based on the tax bracket in which you tend to fall, you will be paying a specific percentage of tax on the respective capital gain. Tax rates tend to fluctuate depending on the personal tax bracket. It also depends on whether the gain was long-term or short-term.
Outside the domains of selling, trading, and buying, if you end up earning cryptocurrencies -through mining, a job, airdrops, staking, node operation, or interest out of lending activities, you become liable for ensuring income taxes on the United States dollar value of the cryptocurrency earnings while receiving the crypto. For the best outcomes, it is recommended to make use of a reliable crypto calculator to analyze the exact tax amount.
Owing Taxes on the Cryptocurrency
When you incur some tax-based event from the cryptocurrency investment activity, you will incur a tax reporting specification. A taxable event is used to denote a condition in which you realize or trigger income or some former realized gains. Some of the core taxable events to consider are:
- Trading cryptocurrency to fiat currency -the US dollar
- Trading one single crypto for some other cryptocurrency
- Spending cryptocurrency for purchasing goods or services
- Earning cryptocurrency in the form of income
Value of Cryptocurrency Taxed
The tax bracket of the personal income, along with the holding period of the crypto assets (either short-term or long-term), will help in determining the amount of tax you will be paying on the crypto income. It will be different for every investor. Moreover, it can be affected by conventional sources of income like job income, stocks, and other forms of investments.
- Tax Events Related to Short-term Capital Gains: Short-term capital gains imply any cryptocurrency held for not more than 12 months before getting sold out. Short-term capital gains do not receive any special tax treatment under the given tax code. These are taxed at the same rate as normal income. Therefore, you end up paying taxes on the short-term capital gains as per the bracket of personal income tax.
- Tax Events Related to Long-term Capital Gains: These apply to cryptocurrencies that have been held for more than a year before getting sold out. The government looks forward to encouraging investors to hold onto the respective investments on a long-term basis. Therefore, the government offers tax incentives for doing the same.
Rates for long-term capital gains on cryptos are available at a lower range than short-term capital gains.
- Tax Events Related to Crypto Income: Cryptocurrency transactions can be classified in the form of income. These are usually taxed depending on the bracket of personal income tax. It would include short-term capital gains, airdrops, staking rewards, interest earnings, and node rewards.
Cryptocurrency Transactions that are Tax-free
In specific instances, there is no involvement of any tax event while transacting with cryptocurrencies. As such, there will be no requirement to pay as well as report any crypto taxes.
There is no requirement of triggering a taxable event in the following cases:
- Holding cryptocurrency
- Utilizing cryptocurrency in the form of collateral for a specific loan
- Transferring cryptocurrency from one wallet to your wallet
Reporting Cryptocurrency Trades on the Tax Returns
Purchasing Cryptocurrency with US Dollars
As you purchase virtual currency with US dollars and keep the same within the exchange while making the purchase or transferring it to the personal wallet, it does not imply that you will owe taxes on it at the year’s end.
If your cryptocurrency-related activity during the given year was only buying a virtual currency with the help of US dollars, there is no requirement of reporting the same to the IRS.
Transactions become taxable when you start making use of the cryptocurrency in the form of an exchange method. It will include selling the cryptocurrency for US dollars, exchanging a single crypto for another (for instance, buying Ethereum with Bitcoin), or paying for specific goods or services with the help of cryptocurrencies.
Whenever you are selling an investment or exchanging the investment for some other investment, it is then a taxable transaction takes place. You are expected to be immensely careful if you are executing trading significantly. If you are entering in and opting out of different types of cryptocurrencies, whenever you will be placing the trade, it will turn into a taxable event.
Minting or Trading NFTs
NFT or Non-fungible Token is a digital token that is formed on a blockchain and proves that you are the sole owner of a unique digital item -whether it is some bespoke art or a digital sports collectible. It is possible to buy as well as sell NFTs in digital marketplaces. Just like cryptos, NFTs are also taxed.
As the IRS has not come up with any specific guidelines for taxation on NFTs, it is slightly difficult to navigate. The tax implications of NFTs will ultimately depend on specific factors -whether you are the NFT investor or NFT creator and the total extent to which you are interacting with the NFTs -in the form of a business or a hobby.
When you are creating or minting NFTs, it is crucial to know about events that are taxable and the manner in which they are taxed. For instance, paying gas fees for NFT minting is a taxable event. Let us assume that you are creating NFTs for fun while spending 0.1 Ethereum on minting the NFT. If you had originally purchased the Ethereum at $100, and it has increased to reach the value of $300 while minting the NFT, then the transaction has created an overall capital gain of $200. In this manner, you will be subject to either long-term or short-term capital gain tax rate -based on the duration for which you have held the Ethereum before using it to create the NFT. However, if you were a professional NFT creator who frequently used Ethereum to mint NFT for your full-time business, then $100 will be regarded as ordinary income.
Once you end up selling the NFT for cryptocurrency or exchanging the NFT for some other NFT, it would create another taxable event. It will be taxed in the form of income as you are earning money for the sale of NFTs. The royalties that you earn for the NFT you have created will also be taxed in the form of income.
For NFT investors, taxes function in a similar fashion to crypto trading. Most NFTs based on artwork are classified in the category of collectibles for taxation purposes. This makes them subject to taxes related to capital gains -just like other common cryptos. The amount of tax you will end up owing will depend on the duration for which you have held the NFT and whether or not you are making a profit. You can also look forward to claiming losses on the NFTs within your taxes.
IRS Tracking the Cryptocurrency
It is mostly assumed that as crypto tends to be anonymous, it is easier to evade taxes. However, it is not so!
Most of the leading cryptocurrency exchanges like Coinbase are known to transmit 1099-MISC forms to the IRS. These forms feature customer-centric information along with a proper record of cryptocurrency income. When the IRS will receive the 1099-MISC form from your exchange but observes no income reported on the respective taxes, your account will be effectively flagged. An automated form of CP2000 letter will be delivered that will alert you of the non-reported crypto income and the overall tax liability.
The IRS uses the available information from crypto exchanges to match unidentified or anonymous crypto wallets to specific individuals.
What Happens When You Do Not Report Crypto Taxes?
When you intentionally do not report your losses, crypto gains, and overall income, it is regarded as tax fraud by the IRS. In such a case, the IRS can go ahead with enforcing multiple penalties for executing tax frauds, including criminal prosecution along with a fine of around $250,000 and 5 years in prison.
In the past few years, the IRS has been aggressively tracking issues related to crypto tax compliances. Additionally, the IRS has also updated it’s United States Income Tax Form 1040 to come up with proper suggestions related to crypto taxes in the United States of America. It is, therefore, important to be completely aware of your crypto gains and losses and how you are applying for the respective tax returns.