How Is Cryptocurrency Taxed?

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What Is Cryptocurrency?

A cryptocurrency is a digital or virtual currency secured by cryptography, making it almost impossible to imitate or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology – a decentralized technology spread across many computers that manage and record transactions. Cryptocurrency is a form of payment that can be exchanged online for goods and services. In simple words, in defining cryptocurrency, we can think of them as arcade tokens or casino chips; you’ll need to exchange real currency for the cryptocurrency to access the good or service. A crucial feature of cryptocurrencies is that they are generally not issued by any central authority, making them theoretically immune to government interference or manipulation.

How Is Cryptocurrency Taxed in the U.S.?

The IRS on Notice 2014-21, through a series of questions and answers, started to clarify how existing general tax principles apply to transactions using cryptocurrency. To start, the IRS stated that virtual currency, like bitcoin or Ethereum, is treated as property for federal tax purposes. Thus, general tax principles applicable to property transactions apply to transactions using virtual currency – cryptocurrency.

The IRS continued to explain that the character of the gain or loss a taxpayer realizes on the sale or exchange of cryptocurrency generally depends on whether the cryptocurrency is a capital asset in the taxpayer’s hands. The IRS’ notice further indicates that all cryptocurrencies should be treated like stocks or bonds (capital assets). When you acquire cryptocurrency and sell it for profit, the IRS will look at the gains as taxable income. So, capital gains taxes will be triggered when buying products/services with cryptocurrency, and the amount of crypto spent has increased in value over what was paid for it. On the other hand, if there is a loss, no taxes will be owed, and there will be no taxes on that transaction, although the taxpayer must still report these cryptocurrency losses to the IRS.

What Is the Cryptocurrency Tax Rate?

Since cryptocurrency will be treated like stocks, capital taxes will be owned on cryptocurrency upon selling it or spending it to realize a profit. The cryptocurrency tax rate for federal taxes will be the same as the capital gains tax rate at this pace.Gains from the sale of capital assets that you held for at least one year, which are considered long-term capital gains, are taxed at either a 0%, 15%, or 20% rate. Compared to short-term capital gains, any income you receive from investments you held for less than a year will be taxed just like your ordinary income, with rates ranging from 10% to 37%.

However, which one of those long-term or short-term capital gains rates applies to you depends on your tax bracket, taxable income amount. The higher your income, the higher the rate. So, for example, if in 2021 you are single and receive $80,000.00 in Capital Gains, your tax rate for short-term capital gains will be 22% and 15% for long-term capital gains.

Income Tax Events

As in any other area of the tax world, it is fundamental to know which situations will result in a taxable event and which does not. A taxable event is any action or transaction that may result in taxes you owe to the government. Anytime a taxable event affects your cryptocurrency investments, an obligation to report it on your taxes rises. Regarding cryptocurrency, these taxable events fall into two categories: capital gains tax events and income tax events.

So, for income tax events, we have, for example, if you received a cryptocurrency payment for carrying a job, you would have to pay taxes over that income received in cryptocurrency. For capital gains events, we will have, for example, that you bought ten bitcoins in a bitcoin transaction for $350.00 each in 2014. Now, you use one bitcoin to buy a new car because the cryptocurrency you are using increased in value over the years, and at the time of buying the car, one bitcoin is worth $64,000.00. In this example, you’ll incur a taxable event when you arrange your bitcoin for the new vehicle (i.e., you make a bitcoin transaction). As a result, you incur a capital gain of $63,650.00 ($64,000 – 350) and need to report it on your taxes.

How To Report Cryptocurrency on Your Tax Return

In the U.S., you are required to report your cryptocurrency taxes via the IRS Form 8949, Schedule D, and, if necessary, the 1040 Schedule 1 and/or 1040 Schedule C.

The first step is to know how much your capital gains or losses are. Once you’ve calculated your crypto taxes, you will need to populate Form 8949. Form 8949 is the tax form used for cryptocurrency capital gains and losses.

Form 8949 is included with Form 1040 Schedule D, which reports your overall capital gains and losses. On this form, you list your totals separately for short-term and long-term capital gains and losses, as indicated on the form. In addition, if you have crypto income, include the crypto income totals on the 1040 Schedule 1; if you are engaging in crypto activities as self-employed, use Schedule C instead.

How the Tax Planning Attorneys at Evolution Tax and Legal Can Help

The subject of cryptocurrency is evolving rapidly and involves many nuances, and it can be overwhelming and complex. If you are interested in cryptocurrency trading or other virtual currency transactions, it is beneficial to discuss the matter with a tax professional and have an experienced specialist working with you. Evolution Tax and Legal has worked on several cryptocurrency transactions to ensure our clients receive the tax benefits that will work for their situation. Our team of tax planning lawyers and CPAs can go with you every step of the way and make it as simple as possible; contact our Tax and Legal Development team for more information.