Our crypto income tax step-by-step guide will help you navigate the process smoothly. Start preparing for the tax season now!
The current tax treatment of cryptocurrencies in the US varies depending on how they are used.
Generally, cryptocurrency transactions that result in capital gains or losses must be reported to the IRS and taxed accordingly. For example, if you sell your cryptocurrency for a higher price than you paid, you have made a capital gain and must report it to the IRS.
Similarly, if you sell your cryptocurrency for less than what you paid, you have made a capital loss and must also report this to the IRS. The IRS handles these two groups quite differently regarding the cryptocurrency tax deductions you’ll face.
In addition to reporting capital gains or losses from cryptocurrency transactions, taxpayers may be subject to other types of taxes, such as self-employment or employment taxes, when they receive payments in virtual currency from their employer.
Cryptocurrency taxation in the US is a complex and ever-evolving issue. As the use of virtual currency becomes more widespread, tax authorities are working to develop an appropriate framework for taxing these transactions.
The IRS now considers cryptocurrency property for tax purposes and requires taxpayers to report gains or losses from their transactions. Taxpayers must also keep records of all their cryptocurrency transactions to accurately report them on their tax returns.
This can be a complicated process due to the decentralized nature of many cryptocurrencies and the need for third-party services such as exchanges or wallets to complete transactions.
In hindsight, it is essential to note that the US government has yet to enact any specific legislation regarding the taxation of cryptocurrencies. As such, this area remains ever-evolving, and taxpayers should stay updated with any new developments to ensure compliance with applicable tax laws.
In light of this, we will go over all you need to know about crypto taxes in the US. We will include how they’ve applied tax rates, capital gains tax, and income taxes. Also, looking at how to calculate them and so much more.
How Does the IRS Classify Crypto?
Cryptocurrencies are a new asset class that has seen tremendous growth in recent years, and with this growth comes increased scrutiny from regulators.
The United States Internal Revenue Service (IRS) is one of the most active agencies regulating cryptocurrencies. They have been issuing guidance on how they should be treated for tax purposes and enforcing action against those who fail to comply.
The IRS doesn’t consider crypto as a form of currency. For federal tax reasons, it considers cryptocurrency to be property. This means that general tax principles apply to property transactions using virtual currency. In short, every time you buy, sell, trade, or use crypto, you may have a taxable event.
The IRS’ stance towards crypto implies that starting now, your gains and losses from cryptocurrency transactions will almost certainly impact your taxes. In other words, if you have any transactions involving crypto in a tax year, you must report it in your tax reports.
How Is Crypto Taxed?
The IRS began questioning taxpayers about using virtual money on their tax returns in 2019.
The inquiry can be found on Form 1040’s front page, asking — “Have you ever received, sold, traded, or otherwise disposed of any financial interest in any virtual or digital currency during the current tax year?.
By putting this query in the spotlight, the IRS clarifies that taxpayers can no longer argue that they are unaware that crypto transactions must be recorded.
As it stands, paying and reporting your cryptocurrency tax(es) is not optional. Should a taxpayer check Form 1040’s crypto inquiry box? Yes, the IRS verifies Form 8949 to see if it has been filed according to its stipulated guidelines.
Capital gains and losses
Purchasing, selling, or exchanging cryptocurrency will result in capital gains or losses in a non-retirement account. Depending on how long you hold the various virtual currencies or assets before selling or trading them, your profit or loss, like other capital assets subject to IRS tax, may be short-term or long-term.
ROI generated are short-term capital gains if you’ve held your cryptocurrency for less than a year before using it or selling it. They are subjected to short-term capital gains tax(es).
Conversely, any profit you earn from selling or using your crypto after you’ve held it for more than a year is considered long-term capital gains. It is, therefore, taxed at long-term capital gains rates.
Short-term capital gains tax is levied at your ordinary income rate, while long-term capital gains are taxed at lower rates ranging from 0% to 20%.
Suppose you receive payouts in crypto for goods or services rendered. In that case, these are considered self-employment income and subject to self-employment tax in addition to regular federal income tax, which could be between 10 and 37%.
Finally, miners who create new blocks of transactions on a blockchain network may be liable for self-employment taxes on their mining rewards, depending on how much they earn per year. It’s also worth noting miners may need to pay taxes(excise) if they sell mined cryptocurrency within one year of receiving it.
How To Calculate Capital Gains and Losses on Crypto
When purchasing and selling capital assets, your gains and losses can be divided into long-term and short-term. The IRS handles these two groups quite differently regarding the cryptocurrency tax deductions you’ll face.
Short-term capital gains and losses
Recap: Short-term capital gains and losses resulting from selling assets you’ve owned for a year or less. In 2022, these gains’ ordinary income tax rate ranged from 10% to 37%.
Long-term capital gains and losses
Recap: The sale of assets you have owned for over a year results in long-term capital gains and losses. For 2022, these gains are subject to advantageous long-term capital gains taxes of 0%, 15%, or 20%.
The precise wage ranges fluctuate yearly. However, we’ve included a comprehensive breakdown below:
- The 10% or 12% tax brackets: You’ll typically pay a 0% capital gain rate if your filing status places you in the 10% or 12% income tax bracket.
- The 22%, 24%, or 32% tax brackets: You’ll typically pay a 15% capital gain rate if your filing status places you in the 22%, 24%, or 32% income tax bracket.
- The 35% and 37% tax brackets: You’ll typically pay a 20% capital gain rate if your filing status places you in the 35% and 37% income tax brackets.
Calculating gain and loss with a cost basis
Determining the property’s cost basis is the first step in calculating your gain or loss. Your cost basis is the original value of an asset for tax purposes. This usually refers to the asset’s purchase price, including associated fees or commissions.
For crypto assets, your cost basis includes all costs associated with acquiring the cryptocurrency, such as exchange fees and transaction costs.
After determining your cost basis, the next step is calculating your capital gain or loss. To do this, subtract your cost basis from the current market value of your crypto assets. If the current market value is higher than your cost basis, you have a capital gain; if it’s lower than your cost basis, you have a capital loss.
The amount of gain or loss will be subject to taxation depending on how long you held onto the digital asset before selling it — short-term/long-term capital gain (concerning your cost basis).
Suppose you purchased 1 Bitcoin (BTC) for $10,000 and sold it for $20,000 five months after the initial purchase. The $10,000 profit you earn is subject to short-term capital gain tax. If, however, you’ve had the Bitcoin for more than a year before selling, then the $10,000 gain is subject to short-term capital gain tax at your ordinary income rate.
Are all crypto transactions taxable?
No, not all cryptocurrency transactions are taxed. The following actions are not taxable events:
- Purchasing cryptocurrency with fiat currency like the USD
- Transferring digital asset(s) between wallets or accounts, you own
- Gifting cryptocurrencies, barring significant gifts that may result in additional tax obligations
- Donating cryptocurrency
Which Crypto Transactions Are Taxable?
Here, we’ll take a look at all crypto transactions that are subject to tax deductions. Let’s go.
Buying or selling crypto as an investment (crypto trading)
Purchasing cryptocurrency in and of itself is not considered a taxable event. Even if the value of your stake rises, you can buy and retain your crypto assets for an indefinite amount of time without having to pay taxes.
The moment you sell, trade, or otherwise dispose of your cryptocurrency holdings in any way that results in you realizing a profit in your taxable accounts. However, taxation is in order. This is not applicable if you trade cryptocurrencies in a tax-free or tax-deferred account, such as an individual retirement account (IRA).
Suppose you purchased $2,000 worth of Bitcoin and sold it for $3,000. You must disclose the $1,000 gain on your taxes in your tax report. Depending on how long you’ve had the BTC before selling, the gain will either be a short-term or long-term capital gain.
Suppose you sell the same amount of Bitcoin for $800 instead of $1,000. You will incur a loss that can be used to offset other profits on other trades and up to $3,000 of your taxable crypto income if your capital losses exceed your gains.
Up to $3,000 of your taxable crypto income per year or any unused losses may be carried over to future tax years as an offset against profits gain.
In the above case study, the taxable event isn’t the crypto purchase. Instead, it’s the sale of the capital asset.
Mining cryptocurrency tax
Cryptocurrency mining is validating and adding cryptocurrency transactions to a blockchain. Miners are typically responsible for mining.
If mining cryptocurrency generates income for you, you must report income earned as gross income. Per IRS Publication 544, the fair market value (FMV) of mined coins at receipt must be reported as gross income. Also, miners may deduct ordinary and necessary expenses incurred with mining activities, such as hardware and electricity costs, under IRC Section 162(a).
Remember that you must report your mining income to the IRS even if you don’t receive a 1099 form, as it qualifies as taxable income and is probably liable to self-employment tax and regular income tax.
Receiving crypto as payment for goods and services
Nowadays, many companies accept payments made in Bitcoin and other cryptocurrencies. In the same way cash, checks, credit cards, or digital wallet payments are taxable income, cryptocurrency payments you receive in return for products or services are also taxable.
Suppose an individual receives cryptocurrency payments for goods or services. In that case, these payments are subject to self-employment tax and should be reported on Form 1040 Schedule C (Profit or Loss from Business).
The fair market value of cryptocurrency received should be reported as gross receipts per IRS Publication 541. In other words, for tax reporting purposes, the amount you are paid in cash for goods or services is equivalent to the cryptocurrency’s fair market value as of when — date and time — you receive it.
In hindsight, IRS guidelines allow you to deduct any expenses you incur while providing goods or services against reported gross income — IRC Section 162(a).
Selling or spending crypto
In the same way that selling shares of stock might result in a gain or loss, mining, buying, or receiving cryptocurrency and then selling it or using it is considered a capital transaction.
Each time you sell crypto you own, you engage in a capital transaction, which necessitates filing a tax return disclosure.
To better let you understand this concept, here’s an illustration of how purchasing crypto that has gained price might be used to pay for travel.
Consider this — on January 10, 2022, you will receive $500 in Ethereum as payment for the services offered. In July of that same year, six months later, your $500 Ethereum is now worth $800, and you use it to pay for plane tickets for travel.
When you file crypto taxes, in this case, you would report the Ethereum you received earlier in January as $500 of regular income (wages if you’re using a W-2 or self-employment income if you’re not an employee getting cryptocurrency as payment) plus a $300 short-term capital gain.
As you can see in the example, you’re reporting two taxable events — receiving crypto as payment (regular taxable income) and selling crypto at a profit (capital gains tax).
Reporting the regular income tax can be done as is. But you’ll have to factor in the $500 ordinary income for the capital gain tax when determining the ETH cost basis. The initial $500 would be subject to two taxes if you pay capital gains tax on the entire $800 — once as ordinary taxable income and once as a capital gains tax.
Consequently, you must deduct the initial $500 from the $800 balance as your first basis.
Keep track of your transactions.
It’s relatively straightforward to track and correctly report these two cryptocurrency transactions. However, let’s say you buy $2,000 worth of Litecoin, put it on a debit card for crypto, and use it over many months to pay for lunches, groceries, coffee, and other things.
Trying to reconcile these transactions at the end of the tax year will be a headache if, like most taxpayers, you view cryptocurrencies as a substitute for cash and aren’t keeping account of capital gains and losses for each of these transactions.
Therefore, paying taxes and keeping track of these transactions to file taxes is crucial.
Exchanges or swap deals between different cryptocurrencies are commonplace among cryptocurrency enthusiasts. This is also a taxable event.
For instance, say you want to swap $800 worth of Dogecoin — previously worth $500 weeks prior — with Ethereum of equivalent price value (also $800). As you paid $500 for Dogecoin, you must declare a $300 capital gain when you make the exchange.
When you acquired Dogecoin in the first place, you established a $500 Doge basis. The $300 capital gain comes from the coin’s appreciation between when you purchased and swapped for ETH coins.
The second taxable event here is the Doge – ETH swap. Here, your new basis will be concerning Ethereum, and the fair market value of Ethereum at exchange time is your Ethereum cost basis — in order words, a $1,000 ETH cost basis.
In the future, it’s crucial to understand that as the US dollar is the currency utilized for your tax return, all of these transactions connect back to them. Therefore, the transaction is still taxable even if you buy a cryptocurrency using another without first exchanging it into US dollars; for example, buying Bitcoin with USDT.
Participating in an airdrop or fork
An airdrop occurs when a brand-new cryptocurrency project debuts and distributes many free tokens to early adopters and their communities to boost adoption as part of a more extensive marketing campaign to promote its launch.
Additionally, airdrops can happen after a hard fork.
What is a hard fork?
A hard fork is a type of blockchain upgrade that creates an incompatible change to the network. This means that nodes running older software versions will no longer be able to join the network or validate transactions.
When a hard fork happens, the blockchain effectively splits in two: one chain follows the new set of rules while the other continues to follow the old. This can result in a new cryptocurrency, as was the case with Bitcoin Cash, created due to a hard fork of the Bitcoin blockchain.
A hard fork can result in a token airdrop when a particular portion of the new token created in the hard fork is distributed to holders of the original token as compensation or reward.
Not all hard forks reward crypto as an airdrop; hence, challenging fork events aren’t always taxable. If a hard fork takes place and is followed by an airdrop where you receive new virtual currency, on the other hand, this translates to ordinary income.
This qualifies as taxable income on your tax return and must be reflected in your tax report (with the relevant, fair market value indicated) to the IRS.
Staking cryptocurrency is holding a certain amount of coins in a cryptocurrency wallet to support the operations of a blockchain network. Investors can earn rewards through additional coins or transaction fees by staking their coins.
Getting cryptocurrency via staking is similar to earning interest traditionally on a savings account. You may get cash payments from investment accounts that are considered taxable income in return for staking your virtual currency.
For tax purposes, staking income is treated the same way as mining income — it is calculated at fair market value at the time of reimbursement and is subject to income and perhaps self-employment taxes.
Reporting Crypto Tax
Depending on the type of transaction, crypto transactions are reported in various ways on federal tax returns. Generally, Form 8949 is used with Schedule D to report taxable crypto transactions on an individual’s federal income tax return.
However, there are other tax forms that the IRS and your cryptocurrency exchange may issue for tax deduction/reporting purposes.
1099-MISC or 1099-NEC
Whenever you profit or gain from a crypto transaction, your crypto exchange will serve you a 1099-MISC form to report the income to the IRS.
The crypto exchange must report any miscellaneous income over $600 to the IRS and the individual who received the payment.
The tax form will report the total income you earned in the year. The customer will use the information from the 1099-MISC form when preparing their taxes to report the income.
Crypto exchanges are only required to issue a 1099-MISC form if the customer has realized a gain or profit from the transaction. If you only incurred a loss, chances are you won’t be served a 1099-MISC form.
Whenever you’re served one of these 1099 forms, the IRS also receives a copy to compare the data on the form to what you disclose on your tax return.
Remember, though, that you are responsible for reporting the income on your taxes, even if you do not receive a 1099-MISC form.
1099-K tax forms report merchant card and third-party network transactions to the IRS.
A 1099-K form shows the total amount of transactions processed through the merchant, and the merchant is required to report any transactions over $20,000 and more than 200 transactions.
Payment processors and merchants mostly use it.
As a merchant, crypto exchanges may issue a 1099-K form to report the total transactions processed through their platform during the year.
This form will show the total amount of transactions that took place during the year, and the customer will use the information from the 1099-K form when preparing their taxes to report the transactions.
It’s important to note that the crypto exchange is only required to issue a 1099-K form if the customer has realized a gain or profit from the transaction, and the exchange will only report the total transaction volume, not the gain or loss.
Additionally, the 1099-K form is not used to report capital gain or loss(change in fair market value). It’s only used to report the volume of transactions. To report capital gain or loss, a 1099-MISC form should be issued.
A 1099-B form reports capital gains and losses (for capital gains tax) from the sale or exchange of securities, commodities, and other property to the Internal Revenue Service (IRS).
Cryptocurrency exchanges may issue 1099-B forms to their customers to report the sale or trade of crypto on their platform. The form will show the sale or exchange details, including the transaction date, the type of crypto, the cost basis, and the proceeds.
If you use virtual currency to purchase products and services, sell them on a cryptocurrency exchange, or invest, you might get a Form 1099-B informing you of these transactions.
The IRS uses the information collected by the 1099-B form to determine whether the individual or entity has a capital gain or loss from the sale or exchange, which may be subject to taxes.
It’s also important to remember that the customer is responsible for reporting the transactions on their taxes, even if they do not receive a 1099-K or 1099-B form. If you have questions about reporting crypto transactions on your taxes, it’s best to consult a tax professional.
Can the IRS Track Crypto Activity?
Despite the anonymity of cryptocurrencies, the IRS may still be able to monitor your cryptocurrency activity.
For instance, if you trade on a cryptocurrency exchange that reports trades to the IRS using Form 1099-B, your crypto activities are no longer incognito, as shown in the form.
In cases where they think tax evasion and/or money laundering may occur, the IRS also uses blockchain analytics tools to identify the crypto activity of digital assets and wallets and link them to specific people.
Consequently, you must include all your crypto-related activities during the year in your tax return to avoid possible enforcement action.
How are crypto taxes enforced?
Although the IRS doesn’t specify how it chooses which tax returns to analyze/audit, the consensus is that it will check the data provided on a tax return, such as the response to the question about virtual currency on Form 1040 or the data on Form 89.
The IRS pays particular attention to those who obtained a Form 1099 from crypto exchanges. Using its computer systems, the agency will vet the forms received from the exchange against what an individual taxpayer discloses on their tax return.
Notably, if a taxpayer receives a Form 1099 from an exchange and responds No to the question about virtual currency or fails to include a Form 8949, they are likely to be audited.
To avoid being the highlight of an IRS tax evasion hunt, it’s always best to give truthful responses.
The bottom line is that taxpayers should keep accurate records of all their crypto-related activities, including dates acquired/sold, descriptions, cost basis/proceeds, gains/losses incurred, the amount received from mining activities, etc., so it’ll be easier to come tax time. Remember, reporting crypto taxes correctly can help you avoid hefty penalties from Uncle Sam!
How to Avoid Crypto Tax
To be clear, you cannot openly evade crypto tax without breaching the law and risking severe fines! But with little tax advice, you can lower your crypto tax rates.
Holding (HODL) onto your assets for longer than a year can maximize the advantage of lower long-term capital gains tax rates.
Know the CGT allowance.
Capital Gains Tax (CGT) allowance is a tax-free allowance that applies to capital gains made on the disposal of certain assets, including crypto. You’re exempt from capital gains tax if you’re in the US and earn less than $41,476 annually. This allowance is $83,351 for married individuals filing jointly. And $55,801 if you are the household’s head.
Utilize tax deductions
Depending on your circumstance, there are several tax deductions that you can exploit to slash your crypto tax bills. Some potentially applicable options include medical expenses deduction, the child tax credit, and 401k contributions deduction.
If you’re a self-employed individual rather than a W2 employee, there’s a viable possibility of deducting your Koinly plan cost from your tax preparation fees.
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Offset losses against gains.
In the US, there is no cap on how much capital losses can be used to offset long and short-term capital gains tax. You can deduct up to $3,000 in capital losses from your ordinary income. As a rule, whenever you incur a loss, do not ignore it; instead, note it down and carry it to offset your future gains.
Track and harvest unrealized losses.
If you have unrealized losses from devalued assets, you can offload them to offset your net capital gain tax. Since cryptocurrency is not officially categorized as a security in the US, the wash-sale rule does not apply, allowing investors to sell their holdings at a loss and immediately repurchase them.
Due to this legal loophole, you can generate fictitious losses and lower your overall tax burden. This practice is referred to as tax loss harvesting.
Exchange one cryptocurrency for another.
If you want to avoid paying high capital gains taxes, consider exchanging one cryptocurrency for another. This process is known as “like-kind exchange,” which lets investors trade one virtual currency for another without incurring any immediate tax implications.
Keep in mind, however, that like-kind exchanges must meet specific criteria laid out by the IRS. This includes both assets being exchanged must have similar characteristics, ownership must occur within 180 days, and neither capital asset can exceed $15000 worth during the transaction.
Use a crypto debit card.
Another great way to avoid taxation while enjoying crypto spending power is using a debit card linked directly to an exchange account.
These crypto debit cards work like regular debit cards but use cryptocurrency funds linked directly from the user’s wallet address instead of fiat currency generated by bank accounts/credit cards, etc.
This method allows users to access their virtual currency funds immediately without worrying about high conversion rates associated with converting back into fiat currency.
As the cryptocurrency market expands, accurate and efficient tax planning is essential for investors. With the proper guidance and understanding of the applicable laws, cryptocurrency holders can stay compliant and benefit from the tax savings available.
It is crucial to note that crypto tax rules are subject to change; therefore, staying informed and updated with the most recent information is critical. Cryptocurrency investors should know their tax obligations and seek professional advice to ensure compliance.
This pertains to the initial value of an asset used for taxation purposes. To determine gains or losses in cryptocurrency investments, a straightforward formula is employed: subtract the cost basis from the proceeds to get the capital gain or loss. It's worth noting that the cost basis can be affected by two additional factors: the accounting method used and transaction fees.
The Internal Revenue Service (IRS) usually handles gains from cryptocurrency in the same way it handles other types of capital gains. This means that if you hold the asset for less than a year, you'll be subjected to ordinary tax rates on short-term capital gains (which can go up to 37% in 2022, based on your income).
If you're holding cryptocurrency purely as an investment and it's not generating any income, you typically don't have to pay taxes on it until you decide to sell it.
No, not all cryptocurrency transactions are taxed. The following actions are not taxable events:
1. Purchasing cryptocurrency with fiat currency like the USD
2. Transferring digital asset(s) between wallets or accounts, you own
3. Gifting cryptocurrencies, barring significant gifts that may result in additional tax obligations
4. Donating cryptocurrency