The Truth About How The IRS Taxes Cryptocurrencies
Cryptocurrency or virtual currency is digital money secured by mathematical algorithms. It is designed to make online transactions extremely secure. One of the reasons why cryptocurrencies are on the rise is because of a well-known technology called blockchain, a decentralized, distributed ledger that records the origin of a digital asset.
While cryptocurrency has been touted as a revolution in currency, a significant investment, and a breakthrough technology, purchasing it can be risky. Why? The IRS has its eyes on cryptocurrency.
To shed some light on cryptocurrency, PGL3 Services has explained the truth about how the IRS taxes cryptocurrencies with a few facts. Keep reading about what they are and how they will affect your crypto-wallet.
Why is Cryptocurrency taxed?
First and foremost, the reason why the IRS wants to tax your cryptocurrency is that many cryptocurrency owners are not reporting or paying taxes on their cryptocurrency transactions. So, in 2014, the IRS issued Notice 2014-21, clarifying that virtual currency is treated as property for tax purposes and not investment security, a common misnomer. This means that cryptocurrency is taxed as a capital asset, and every taxable event must be reported on an IRS 8949 cryptocurrency tax form. So you can either benefit or be adversely affected by how you account for cryptocurrencies transactions on your tax return!
What you can do in such a situation is tax plan accordingly, which ensures savings on taxes while simultaneously conforming to the legal obligations and requirements of the Income Tax Act. Further, the primary objective of tax planning is to save money and lessen one’s tax burden.
Here is a summary of the cost and benefits of tax planning for cryptocurrency transactions:
Benefits
a. Cash Savings
b. Reduce Tax Liability
Costs
a. Higher Taxes
b. Interest
c. Penalty
d. Fines and imprisonment
The facts!
Cryptocurrencies are taxable when:
a. Received as compensation
The IRS considers compensation in the form of cryptocurrency as income equivalent to cash compensation and is taxable at your tax rate. Additionally, in the future, when you sell the cryptocurrency, it will trigger another tax event: short or long-term gains or losses.
b. Used as payment to employees, contractors, and vendors
When you use cryptocurrency to pay someone else, it’s still a taxable event for you as much as the recipient: employee, contractor, or vendor. You have “sold” an asset in the eyes of the IRS when you dispose of it.
And whenever you sell property, you trigger the capital gain taxation rules. You’ll have to pay taxes on any difference between your basis and FMV on the date of sale, which might be large given the volatile nature of cryptocurrencies.
c. Mined, hard forked, or airdropped
Mining is the process through which individuals (or mining groups) audit previous cryptocurrency transactions, confirm that there has been no double-counting, and update the blockchain public ledger.
Miners are rewarded for their efforts and receive new units of cryptocurrency. Again, cryptocurrency is considered property by the IRS, and the receipt of any property is a taxable event, even if it’s not received from an employer.
A hard fork is when a cryptocurrency splits in two because of a blockchain’s software change. The update creates a new form of cryptocurrency that diverges from the previous one. Also, this creates a taxable event generating a gain or loss.
The IRS also issued guidance stating that airdropped units are to be included in a taxpayer’s gross income at their FMV.
d. Traded for other cryptocurrencies
Like most clients, you may believe that trading cryptocurrencies for others trigger a like-kind exchange rule in the IRS Code Section 1031. The section allows you to defer taxes on your property sales indefinitely if you use your sale proceeds or trade directly for another property of the same kind.
The Tax Cut and Jobs Act (TCJA) affirmed that cryptocurrencies do not qualify for like-kind treatment. As such, trading units of one cryptocurrency for units of another is the same as using it to purchase goods or services for tax purposes. As a result, a taxable event has occurred.
The myths!
a. You don’t have to report your Cryptocurrency transactions
Like some clients, you may believe that if the cryptocurrency platform does not report the client’s activity to the IRS, you do not have to report gains from the sale of cryptocurrencies. Know that the IRS considers this action as tax evasion! You should report all income and gains from cryptocurrency transactions.
b. The IRS allows a $10,000 “Personal Use” Exemption on cryptocurrencies
There’s folklore floating around that when an individual claims an exemption for cryptocurrencies up to $10,000, assets under the limit would be tax-free. This is false, and you could significantly under-report your income!
c. Stolen or lost cryptos are tax-deductible
Whether you have stolen or lost cryptos, the IRS has its clear rules: it cannot be claimed as a capital loss!
How is cryptocurrency taxed?
Cryptocurrency is considered property and is taxed as a capital asset, and every taxable event must be reported on an IRS 8949 cryptocurrency tax form.
1. Non-taxable events
Buying cryptocurrency is not a taxable event; rather, it sets the taxpayer’s cost basis in the asset. Gifting cryptocurrency is also not a taxable event. (Excluding large gifts that may trigger other tax obligations).
Gifting cryptocurrency may help you avoid taxation on your gains. The recipient won’t have to pay a gift tax, either. Under current rules, you can give up to $15,000 per person per year without filing a gift tax return or paying any gift taxes. Even if you exceed the $15,000 limit, you still won’t have to pay gift taxes unless you’ve used up your entire $11.7 million lifetime estate exemption.
2. Taxable events (Capital and Income)
a. Capital Includes:
• Selling cryptocurrency for fiat currency (like the pound sterling, the euro, and the US dollar).
• Using cryptocurrency to buy goods/services.
• Swapping or trading one crypto asset for another.
b. Income Includes:
• Earning crypto interest from decentralized finance (DeFi lending)
• Receiving crypto via an airdrop
• Receiving crypto payment for carrying out a task (this includes bug bounties)
• Earning crypto from staking and liquidity pools
• Earning crypto mining income from transaction fees and block rewards
3. Cryptocurrency fees and cost basis
Before the Tax Cuts and Jobs Act (TCJA), certain investment-related expenses were eligible for itemized deductions. For tax years 2018 to 2025, these deductions have been eliminated. However, cryptocurrency traders can still save money on their transactions fees by adding the cost of fees into their cost basis on the acquisition of crypto and deducting fees from the proceeds from the disposition of the asset.
The United States distinguishes between long-term and short-term capital gains. If you hold a particular cryptocurrency for one year or less, your transaction will constitute short-term capital gains. Short-term capital gains are added to your income and taxed at your ordinary-income tax rate.
4. Tax rates (Long vs. Short Term Gains)
a. Short-Term Capital Gains
Short-term capital gains are taxed as ordinary income
b. Long-Term Capital Gains
If you have held a particular cryptocurrency for more than one year, then you are eligible for tax-preferred long-term capital gains. In 2021, the capital gains tax rates are either 0%, 15%, or 20% for assets held for more than a year. Capital gains tax rates on assets held for less than a year correspond to ordinary income tax brackets (10%, 12%, 22%, 24%, 32%, 35% or 37%).
For single filers, you will pay:
• 0% in long-term capital gains if your income is $0 to $40,400
• 15% if your income is $40,401 to $445,850
• 20% if your income is $445,851 or more
For married filers filing jointly, you will pay:
• 0% if your income is between $0 to $80,800
• 15% if your income is between $80,801 to $501,600
• 20% if your income is $501,601 or more.
For more details on cryptocurrency, reach out to PGL3 Services. We are tax preparers, accountants, and business consultants in Florida, with over thirty years of experience dedicated to helping businesses with accounting, financial reporting, and taxes. We have CFOs on our turnkey team who are experts in the construction industry. When it comes to service cost, we offer flexible plans based on the complexity of your business.
We serve clients across Pembroke Pines, Daytona Beach, Miami-Dade County, Broward County, Palm Beach, and the surrounding areas.
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