For most mainstream investors, cryptocurrency has an aura of mystery. It is a decentralized medium of exchange, and transactions are virtual and anonymous. That makes it an attractive tool for the underground marketplace. Regulatory agencies have struggled to create tax laws for people who use cryptocurrency. The biggest obstacle – and the one of greatest concern – is crypto taxes.
Governments want their share when it comes to profits from cryptocurrency. Lawmakers and regulatory agencies are quickly putting tax requirements in place. More importantly, they are interpreting existing tax law as it pertains to cryptocurrency. They are also enforcing payment of crypto taxes for anyone who profits from this type of asset.
Understanding how tax law applies to your cryptocurrency profits is critical for staying on the right side of the law, whether you are generating income from capital gains or earning rewards through mining and staking. The experts at Founder’s CPA can help. They are up-to-date on the latest developments in crypto tax law, and they have the skills necessary to guide you through the complexities of calculating your crypto taxes.
Three Ways to Make Money From Cryptocurrency
IRS guidelines direct taxpayers to treat cryptocurrency like property. It has value for the purpose of exchanging goods and services. However, it is not currency like US dollars, EU euros, or Japanese Yen.
There are three main ways that people make money from cryptocurrency. If you take part in any of these activities, you may owe taxes.
Buying and Selling
The value of cryptocurrency goes up and down like the value of US dollars goes up and down when compared to other countries’ currencies. If you buy cryptocurrency and sell it for a profit, consider this income. You may be responsible for capital gains taxes. Compare this to the taxes you pay when you buy real estate and sell it for a profit.
Investors who don’t want to buy cryptocurrency can still profit when it increases in value. Accomplish this by purchasing shares of managed funds that focus on cryptocurrency investments. Some of these funds invest in companies that work with cryptocurrency. Others invest in actual cryptocurrency, relying on changes in value to realize profits. As with trading actual cryptocurrency, if you sell your fund shares for more than you paid, your profits may be subject to capital gains taxes.
Mining and Staking
Some cryptocurrencies generate new coins through a process called mining. Miners confirm other users’ transactions to ensure that accounts are current and accurate. They validate a group of transactions called a “block“ and add the blocks to the blockchain. The blockchain is the official record of transactions. Completing this task, along with other activities, makes miners eligible to receive rewards. The reward is newly generated cryptocurreny. If you receive payments like this, consider them income that is subject to crypto taxes.
Other cryptocurrencies generate new coins through a process called staking. Coins go into digital “wallets” for validating transactions. The owners of these coins earn rewards in the form of new cryptocurrency. Of course, these rewards come with tax liability.
The big question for most is how to report income from any of these activities on tax returns. The best solution is to seek a tax professional with experience in cryptocurrency, like the specialists at Founder’s CPA. These experts know how to accurately report cryptocurrency income to meet tax requirements without creating unnecessary crypto tax liability.
Reporting Cryptocurrency Income on Taxes
In the first few years of cryptocurrency trading, most people did not report these transactions on their taxes. After all, cryptocurrency isn’t mentioned anywhere on tax forms. However, there is now specific guidance on how to report income from cryptocurrency. Today, the IRS carefully monitors compliance.
Report All Trades and Sales
Now that the IRS looks closely at crypto taxes, it is critical to report every trade and every sale. This includes selling cryptocurrency for dollars. Trading one form of cryptocurrency for another also counts. So does making a purchase using cryptocurrency.
Form 8949: Sales and Other Dispositions of Capital Assets
The first tax form you need is a standard Form 8949. This is where you list all your cryptocurrency activity. The quality and detail of your record keeping comes into play here. You will have to list the following information for each transaction:
- Date Acquired/Purchased
- Date Sold
- Cost of Trade
- Net Gain/Loss
The form has two sections: Short-Term and Long-Term. Short-Term refers to assets you have owned for one year or less. Long-Term refers to assets you have owned for more than a year.
Form 1040: Schedule D
As you complete your Form 1040, you have to move information from Form 8949 over. This ensures your income and tax liability calculations are accurate. Use Schedule D to complete this task. Note that you can carry cryptocurrency losses over from year to year as you would with any other investment. If this situation applies to you, record it on Schedule D.
Income From Mining
If you earn rewards as a cryptocurrency miner, you are self-employed for tax purposes. Report the rewards you earn with your other income. The rewards are subject to the same tax rate you pay on other types of income from self-employment.
The tricky part is converting the cryptocurrency you received to US dollars. IRS guidelines state that you must use the fair market value of the cryptocurrency as of the date you received it. The key here is to apply the same method of evaluating fair market value for every transaction. As long as you choose a reasonable method and implement it consistently, you are likely to be in compliance with IRS regulations.
Finally, it is important to remember that if you receive cryptocurrency as payment for any work you do, it is subject to income taxes. Include it in your gross income when you report income from all other sources.
Because the IRS considers cryptocurrency to be property, payments made with cryptocurrency fall under bartering regulations. Review the Miscellaneous Income section of IRS Publication 525, Taxable and Nontaxable Income. It provides more details on your responsibilities.
Strategies for Bringing Your Tax Bill Down
Most investors already have strategies for keeping their tax bills low. The good news is that many of these same strategies will work for crypto taxes, as well. These are a few of the most valuable:
Focus on Timing
As with any investment, the best way to make a profit is to buy cryptocurrency or fund shares when the price is low. Then, sell when the price goes up. However, in years when income is high, you may want to hold off on selling. If you wait until a year when your income is less, you may fall into a lower tax bracket. That means you will pay less in capital gains taxes.
Short-Term vs. Long-Term
The amount you pay in capital gains taxes depends on how long you own the asset. In this case, the asset is cryptocurrency. If you hold your cryptocurrency for more than a year, you may be eligible for the lower, long-term capital gains tax rate. Taking advantage of this strategy requires exceptional record keeping.
Examine Your Expenses
Mining often requires specialized computer hardware and software. You also pay the cost of electricity to run your computers. The expenses you incur to generate mining income may be deductible.
Consult Your Tax Advisor
Some people interpret crypto tax law differently for cryptocurrency tokens and cryptocurrency airdrops. They believe these assets are not subject to taxation. If true, this is simply because the regulations have not yet caught up with the technology. Work with your tax advisor to determine exactly what income and assets belong on your returns.
Cryptocurrency has entered the mainstream financial world. The IRS is taking a hard look at whether taxes are being collected accurately. Some cryptocurrencies are reporting transactions directly to the IRS. It is likely that this will become standard practice in coming years. If it does, hiding cryptocurrency income will not be possible.
Don’t risk running afoul of the law by failing to pay your crypto taxes. The penalties can be substantial. As with any type of tax fraud, you could be responsible for back taxes, fees, and penalties. Deliberate fraud carries a sentence of up to five years in prison and a fine of up to $250,000.
Founder’s CPA Group has the experience necessary to ensure that your tax returns are complete and accurate. These experts understand the nuances of crypto taxes. They will ensure you comply with tax regulations – and that you don’t pay more than your fair share. Schedule your free consultation today.