Bitcoin seems to be everywhere these days. From its unknown origins in 2008, it has developed and matured into a broadly recognized real currency used in almost everything, investing, buying goods and services, and paying employee wages. However, many Bitcoin users are not aware that buying/selling, exchanging, and even virtual currency transaction have tax implications. In some instances, spending your Bitcoin can be envisaged as a profitable investment, therefore liable to taxation. Here are the basics of Bitcoin tax – the reasons for the tax and why you could get in trouble if you don’t know your tax obligations.
The IRS and virtual currency
The Internal Revenue Service (IRS) has made it difficult for Bitcoin users to conceal crypto transactions, whether deliberately or not. The authority added a new question on top of the tax form asking, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The only choice is to answer yes or no. If you answer falsely, you could land in hot soup with the United States federal government, which is flushing out crypto tax evaders.
The IRS regards virtual currencies as a capital asset treated as a property when it comes to crypto tax. Much like stocks and bonds, any profits or losses accrued from selling, exchanging Bitcoin are taxed as gain or loss. Similarly, any gains made by mining Bitcoin or any other crypto are subject to taxation. When a taxpayer mines BTC successfully and makes gains from engaging in the activity, whether, in BTC form or any other form, the revenue ruling is to add to their gross income. The value is determined as of the time the miner received the virtual currency.
Customers who don’t receive any tax form from Coinbase and sold or converted crypto from 2020 are still responsible for reporting to the IRS and should consult a tax professional. Every registered crypto exchange is required by the IRS to report crypto transactions. Coinbase does report your crypto activity to the IRS if you meet certain criteria. If you do not receive the 1099 form, you are still required to report all of your cryptocurrency income on your taxes. Not doing so would be considered tax fraud by the IRS. Beng sent a notice of deficiency by the IRS means that a taxpayer owes additional income tax (and often interest on that amount, plus additional penalties).
How is Bitcoin taxed?
Cryptocurrency taxes are based on the IRS decision in 2014 that ruled that crypto-assets like Bitcoin should be subjected to taxes like stocks and bonds. The ruling has enormous implications for crypto holders since it subjects them to more complicated taxes. However, capital assets are only subject to taxation, particularly crypto taxes, when sold at a profit.
For instance, let’s assume that you purchased $50 in Bitcoin. You hold the crypto-asset until its value reaches $500. If you spend the $500 to buy household stuff, you owe the Internal Revenue Service capital asset gains taxes on the $450 you made regardless of whether you used it as a currency or sold it.
The most important thing to bear in mind is that in the eyes of the IRS, Bitcoin is a property. Regardless of how you intend to use it, Bitcoin and altcoins are not a real currency but capital assets. This means they are taxable similar to stocks. To long-term BTC holders, this is a good thing since they are subjected to better tax conditions. According to Eric Pritz, a significant partner at Signature Estate & Investment Advisors, “Currency is taxed at ordinary income rates, which is less favorable than capital gains tax rates.”
If you hold BTC for more than 12 months before selling it at a profit, you are only charged 15 percent gains taxes. Twenty percent for taxpayers earning $441,450 and above, and 0 percent for persons earning below $80,000. On the contrary, if you hold Bitcoin for 12 months or less before liquidating, you are subjected to regular income tax rates on any profits depending on the tax category you fall in.
The way you receive crypto matters during taxation. There are a handful of Bitcoin transactions that are not liable to immediate tax. If you receive a virtual currency as a gift or donate it to charity, they are not subject to taxation. However, once you sell your virtual currency gift, you must pay crypto taxes; hence, you need to figure out the cost basis of your gifted crypto. This entirely depends on whether or not you have made a profit after selling it. Moreover, the donor is also under no tax obligation if the donated digital asset’s value is under $15,000. However, if it is above $15,000, the donor must file a gift tax return.
Why is Bitcoin taxed?
The IRS decision to tax cryptocurrencies as capital assets might have been influenced by how most people use them, as per the UNC Tax Center’s research director, Jeff Hoopes. According to Hoopes, most individuals hold Bitcoin as an investment and the IRS taxes profits made by holding capital assets.
However, the decision to tax Bitcoin by the IRS might have been a pragmatic gesture, according to Jon Feldhammer, a tax partner at Baker Botts. With cryptocurrency trading volumes on cryptocurrency exchange reaching tens of millions of dollars daily, it was evident that the tax authority was missing tax revenue from a substantial fountainhead, as per Feldhammer.
When do you have to pay taxes on Bitcoin?
The IRS states that if you are paid in Bitcoin for goods and services, you must include it in the fair market value of the coin in U.S. dollars in your total revenue. Crypto transactions are converted to United States dollars. The fair market value of Bitcoin is determined by translating them into U.S. dollars at the market rates when they were obtained.
Besides, you are also liable to capital assets tax gains if you sell Bitcoin since the IRS treats it as a property. Gains represent profits, and profits are taxable regardless of whether they are paid in digital assets.
For instance, you might want to acquire a property like a home, own it for a while, and then decide to get rid of it by either selling, trading it, or giving it away. This is the point where capital gains taxes come into play. Four things are likely to occur when you get rid of a property and prevent a case of tax evasion:
- Profit from gains.
- Gains are determined by calculating the dollar value changes between the cost basis and the profits realized after getting rid of the property.
- Sales tax rates rely on whether the virtual currency was held for more than 12 months or less. Tax year matters.
- Asset capital gains are reported using schedule D or filling Form 8949 or Form 4797. The forms need the taxpayer to reveal the evidence of calculations when determining capital gains or loss.
Recordkeeping is vital in crypto taxation
To ensure you are on the right track of the tax authorities as a cryptocurrency investor, you must carefully keep your virtual currency transactions record. It would be best if you recorded the fair market value of Bitcoin immediately after mining or purchasing it. Besides, you also need to register the fair market price after disposition. This data is essential in computing your Bitcoin taxes.
Such data might not be readily accessible. For instance, in the stocks’ case, the broker provides the buyer with Form 1099-B, which would display the cost basis of your purchase. For Bitcoin, this form is not provided, and it’s one of the key reasons why most people are unaware of their cryptocurrency tax liability.
Form 1099-K may be provided if a Bitcoin investor transacts over $20,000 in payments and about 200 cryptocurrency transactions annually. However, these two requirements must be fulfilled, and not a lot of people transact Bitcoin 200 times a year. Regardless of whether you reach this limit or not, you still owe the tax authorities income tax.
Although failing to report or pay your crypto taxes might be a genuine mistake, the IRS will never listen to any excuses. The tax authority has filed a lawsuit against one crypto broker for many clients who might have failed to report their crypto profits. Losing your crypto to swindlers can turn out pretty bad, and the tax treatment will not be fair. Before, you could have subtracted it as a theft loss on your taxes. But the new set of rules got rid of removing for personal theft cases.
How to prepare and report Bitcoin tax filing (step-by-step)
To maintain a proper record of your crypto transactions, it is essential to understand how different crypto events are taxed. Depending on the type of crypto activity you are dealing with, here are the various taxable events you should keep in mind while preparing to report to the IRS:
If you are paid for goods and services using Bitcoin, the holding period does not matter since they are taxed as regular income. The federal tax rate on regular income ranges from 10-37 percent marginal tax rate. Moreover, state income taxes might be included.
Cryptocurrency miners also pay taxes. New cryptocurrency gains obtained through Bitcoin mining are treated as taxable income. Moreover, the Bitcoin miner might be subjected to self-employment tax on top of the mined Bitcoin. Bitcoin mining is a taxable event.
If tokens are obtained through a hardfork or any other crypto event such as an airdrop, they are liable to ordinary income tax.
Short term and long term capital gain rate
In 2018, the short-term capital gain was treated as taxable income, and this applied to a crypto transaction in which the coin was held for less than one year. However, long-term capital tax gains rates did not change, and they are charged at rates of 0,15 and 20 percent, which depends on the crypto trader’s tax bracket.
The long-term capital gains tax applies where a new cryptocurrency transaction occurs after being held for more than one year before disposition. Notably, wallet to wallet transfers is not liable to taxation regardless of whether it has been held for more or less than a year. This is because the digital currency has not changed ownership, and it has not been converted to fiat currency at any point.
Limitations to a capital loss carryforward
There are no restrictions to the number of capital gains liable to taxation. Nevertheless, there is a restriction on how much you can carry forward as a loss in particular circumstances. You can carry forward a maximum of $3,000 yearly in losses to counterbalance your income. Assuming you made $30,000 in profits, a carryforward loss can probably minimize your tax bill to $27,000.
More so, if you made capital gains during the same year, your carryforward losses could be first included in your capital gains, and the remaining losses could be included in your income up to $3,000. Excess losses than the maximum limit can be used to counterbalance capital gains or reduced crypto income tax can be carried forward for use in the future until all the loss has been used up entirely.
Determining cost basis
The cost basis is essential to calculate whether you have a gain or a loss. Simply put, the cost basis refers to the amount you paid to acquire a cryptocurrency in United States dollars. Precisely, the cost basis for any capital is the amount you paid plus any other adjustments. However, in the case of Bitcoin, the cost basis comes down to the purchase price since there are no adjustments or improvements made. For instance, if you buy BTC for $1,500, the cost basis is equal to $1,500.
To narrow down this further, if you buy Bitcoin for $1,500 and exchange it 12 months later for Litecoin, you are required to note down the price of Bitcoin and Litecoin during the exchange time. Assuming that your Bitcoin was trading at $3,000 when you sold for $3,000 Litecoin, you would have $1,500 in long-term capital gains on Bitcoin and a cost basis of $1,500 on the Litecoin you obtained.
Determining the precise figures can be easier if you use major crypto exchange platforms like Coinbase. It is possible to download a report of all your convertible virtual currency transactions on Coinbase with the click of a button in many instances. If you deal with a single cryptocurrency on one or two brokerages, it would be easier to track the records and make the calculations to prepare a tax report. However, if you are trading bitcoin with more than one crypto on many marketplaces, you have extensive research work waiting for you. However, each tax rate required is readily available on crypto wallets or exchange platforms’ reports of the brokers you have used.
Tools for Bitcoin tax
Cryptocurrency tax software might vary in features and functionalities. Still, they are all designed with a common goal: helping a crypto user or a crypto investor with IRS guidance in terms of capital gains. The need for a tax tool like Taxact for Bitcoin entirely depends on your jurisdiction since some countries don’t need you to pay taxes for crypto transactions.
Different countries have different policies; hence, crypto investors need to know the regulations that apply in their respective jurisdictions. If the laws of your country of residence need you to pay Bitcoin taxes, you require software to help you fill up a tax form and payment every tax season. Some of the factors to consider before selecting a crypto tax tool include:
- The creator
- Historical data
What is a Bitcoin tax calculator?
A Bitcoin tax calculator works by extracting data from your exchanges, crypto wallets, or other cryptocurrency platforms. The tool calculates the gains, losses, and business income tax returns from your cryptocurrency trades. The device simply helps Bitcoin investors determine their tax implications and prepare a tax report. Some of the best crypto tax software to help cryptocurrency holders determine the tax you need to pay from your cryptocurrency investment include:
TurboTax is much more costly than any other software out there, but most people find the accessibility of human assistance worth the additional fee. The software provides a free version for simple crypto tax filings. Its user interface is earlier to use and appears like a chat with a tax professional, but you can also skip around if you need to. With its insightful design and a wide variety of support options, TurboTax sets the standard for the do-it-yourself tax preparation sector. It makes it easy to prepare a crypto tax report.
This software makes it easier to calculate and file taxes through its innovative tools. It enables traders to easily import trades and transactions through smart transfer matching using AI technology to recognize transfers between wallets while still noting down the original cost of every Bitcoin transaction.
The crypto software is alleged to have more than 650,000 active users, including over 750 corporate tax clients. The crypto tax tool has more than a decade of historical data and a combined portfolio worth $4.3 billion. The platform allows the integration of more than 70 crypto exchanges; hence, it is ideal for large-scale cryptocurrency traders.
The IRS published its first set of new crypto tax regulations back in 2014, and only about 900 crypto users reported profits or losses made through cryptocurrency trades between 2013-2015. With the IRS intensifying its crackdown on tax evaders, cryptocurrency investors need to keep proper records and be prepared for any investigation, crypto tax payment, or even penalization. Every cryptocurrency user should be aware of their tax reporting requirement or seek tax advice from a tax attorney for tax purposes.