Last Updated: August 25, 2020
Cryptocurrency made its debut in 2009, and since then there has been much confusion on how to report cryptocurrency earnings for an individual’s income tax return. If you own cryptocurrency or are interested in the subject, this article will shed more light on how taxes apply to cryptocurrency and how it impacts your income tax return.
How Does the IRS Treat Cryptocurrencies?
As of 2014, the IRS declared tax stipulations on digital currencies. The IRS states that they consider bitcoin and other cryptocurrencies a “property” asset and therefore sales of the currency may qualify as capital gains or losses depending on the situation. Those who receive cryptocurrency as payment for goods and services also must report those earnings on their individual income tax return. The full scope of tax considerations and obligations for cryptocurrencies has remained a source of confusion even for some CPAs when calculating income tax returns.
The IRS has not made a formal declaration in terms of a tax code that provides complete clarity. Notice 2014-21 provided guidelines that shed more light on the subject, but the IRS also recognizes the taxation of cryptocurrency is still up for discussion, and they encourage the public to reach out to them regarding the subject.
This is how taxes work on crypto for now, but it is likely to be adjusted in the future as cryptocurrencies make their way into more and more industries and facets of life.
Although cryptocurrency is not considered legal tender for goods and services, the IRS does not see that it should be treated differently than other income or taxed assets. Depending on each person’s individual circumstances when they file a tax return, transactions involving cryptocurrency may trigger a tax. Here is a list of possible situations that would incur a tax (keep these taxable events in mind when you plan to buy or sell your cryptocurrency):
- Sell your tokens. If you sell them, then depending on your cost basis (fair market value at the time of purchase) plus your gains when sold (if any); you will be subject to tax based on your regular income tax bracket
- You exchange them for another crypto asset. As with other currency exchanges, if you profit from the exchange, this will trigger a tax
- If you pay for any goods or services.
- Giving your tokens to another person or charity. In most cases, gifting does not result in taxes for the giver. However, depending on each person’s lifetime gift-giving amount, as it relates to the taxable threshold, this event may be taxable.
- Donating to a qualified non-profit charity. For-profit and non-profit charities differ in the eyes of the IRS. If you plan to donate, find out if the charity is a for-profit or non-profit organization and whether it has tax-exempt status. Do this before you elect to file a donation on your income tax return.
- Buying crypto with cash and holding. Since you are purchasing your cryptocurrency with after-tax dollars, the purchase itself is not a taxable event. You do not get a deduction or credit for the purchase.
How to Pay Taxes on Cryptocurrencies
You should report cryptocurrency transactions along with your other earnings. Not filing your taxes related to crypto holdings or spending may cause you to be the subject of scrutiny. The IRS organized a campaign and sent out letters to bitcoin owners suggesting they may need to amend their prior tax returns to comply with cryptocurrency income reporting.
Know What You Owe
For individuals and businesses buying and trading in bitcoin/cryptocurrency, or using it for transactions for goods and services, it will be easier to use a cryptocurrency tax calculator to understand things like the crypto tax on earnings. Not accurately reporting the value of your cryptocurrency or profits will cause fines and penalties. Better to be safe than sorry. If you have a CPA, then this person can help you understand the tax implications and they can complete your tax return for you. In any case, here is an example to give you an idea:
Let’s say that your income tax filing status is single. Your gross income each year is $100,000 and your adjusted gross income is $87,800. This puts you in a 24% tax bracket, thus resulting in a capital gains bracket of 15%. Let’s say you bought $1,000 in cryptocurrency over a year ago and sold it for $2,000 in 2019.
Adjusted gross income $87,800 (single filer) 24% income tax bracket and 15% capital gains tax bracket.
2019 Bitcoin Sell: $2,000 –
2018 Bitcoin Buy: $1,000
Profit: $1,000 x 15% = $150.00 capital gains tax on cryptocurrency
Reporting is on You
Just as you have to report your income from earnings or other non-income-earning assets, cryptocurrency is no different. Each country has its own set of laws regarding taxation so be mindful of your transactions where you live.
Don’t Hide Anything
The IRS has its ways of finding out information; they have put a notice out to cryptocurrency users to remind them of the tax implications related to cryptocurrency and their tax returns. Hiding information from the IRS can impose levies, withholdings, and freezing accounts or other assets you own.
Adhering to IRS Guidelines
It is crucial to understand how the IRS sees cryptocurrency as it relates to taxes today, and how they may view it later. Since they have not come out with a formal code, it can still be confusing despite the notices they give. If you are new to cryptocurrency, make sure you stay informed as to how you can avoid penalties from inaccurate or failed reporting. Failure to report any activity relating to cryptocurrency has the same laws and penalties as any other income reporting liability.
The IRS does not care if you bought bitcoin and made small gains or large gains. They require all income tax filers to report any taxable bitcoin transactions on their income tax return.
Cryptocurrency, despite being in its infancy, is becoming more recognized — and though it is not recognized as legal tender, it is not illegal to use cryptocurrency for payment or investments. Just make sure you are keeping a detailed record of your cryptocurrency activities and accurately report them to the IRS on your income tax returns. If you remain uncertain, a CPA can guide you on how to accurately report.
Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.