How to file crypto taxes: A guide to cryptocurrency taxation and laws

How to file crypto taxes: A guide to cryptocurrency taxation and laws

There are millions of Americans who engage with cryptocurrencies in one form or another as they continue to be adopted across the financial world. Unsurprisingly, with the success of crypto comes the tax authorities, who are eager to collect their share of the revenue from activities such as cryptocurrency trading, mining and interest earned through decentralized finance (DeFi) platforms.

However, it seems like it wasn’t long ago that cryptocurrency was a niche field that only involved people who were especially tech-savvy. In those days, the exact rules for reporting and paying cryptocurrency taxes were unclear. Many of those using the various currencies didn’t even bother reporting because crypto was still believed to be under the radar of most tax authorities. Authorities are playing catch up though, and it’s time to acknowledge that they are now working hard to establish cryptocurrency taxation rules.

Whether you are new to crypto trading or have been at it for some time, you need to report your income and pay the taxes that apply, in accordance with local regulations. With that said, it can be complicated and confusing. It can be even worse if things are left until the very last minute. If you participate in the market in any way, you should maintain records and try to understand the tax implications of every transaction.

Why you need to file crypto taxes

The first reason you need to file crypto taxes is that it is the law, and it’s always better to stay on the good side of the tax authorities. In the early days, crypto was seen by many as a financial gray area, with regulators calling it out for being used for illicit transactions and to hide income or launder money. As with any other means of payment, this still occurs in the cryptocurrency world. However, governments have now started to implement tools that make use of one of the core characteristics of blockchain technology: transparency.

While the reporting done by exchanges does not reach the very high standards related to more conventional investments like stocks, compliance is building with every passing year. Authorities are focusing on crypto more than ever, and they are starting to demand more reporting from exchanges. The United States Internal Revenue Service is also seeking a budget increase that would strengthen crypto tax enforcement.

Even if you haven’t received any tax documents associated with crypto trading, that does not mean you do not have any taxable events. You need to report all of your activities, regardless of whether you believe the exchange reported them or not. If you fail to do this, you could be the subject of an audit.

Crypto profits are treated as capital gains income

If you have ever turned a profit and paid taxes on traditional capital assets like stocks or bonds, some of the tax issues associated with crypto will seem familiar — that is because the IRS treats cryptocurrency as property. That means that if you make money, you will pay capital gains taxes in a way that is similar to paying taxes on gains from stocks or bonds.

Take the selling price of the asset and subtract the cost basis; the difference represents the amount of profit you made from trading a particular cryptocurrency. From there, your cryptocurrency tax liability will depend on whether you held the coin for less than a year or more than a year.

If the holding period was less than a year, you pay the short-term capital gains tax, which can range from 10% to 37% in the United States, depending on the tax bracket you happen to be in. If you held the position for more than a year, you are subject to the more favorable long-term capital gains tax. The long-term rate can be 0%, 15% or 20%, depending on your tax bracket.

Crypto taxes cover more than just investing

Think you are off the hook because you didn’t trade crypto as an investment? Think again. All sorts of cryptocurrency uses are subject to taxation. Even if you are just a consumer using your coins to make purchases, this should be reported on your tax return. Even trading one cryptocurrency for another is something that needs to be reported.

Let’s say you are buying cryptocurrency and using it for simple purchases. That might not seem like a form of income, but to the IRS, it is. If you bought those coins and the price went up, thus making it possible for you to get more from that money, it is technically a capital gain. It should be reported, and you should pay taxes on it.

Those who get paid in cryptocurrency for their work also have to report the income to tax authorities. One way to make it easier to report income is to receive the payment in crypto and then exchange the cryptocurrency into dollars. You can then report your personal income in its dollar value. If you choose to hold the coins and allow them to gain or lose value, that could complicate things for tax reporting purposes.

If you are making money through cryptocurrency mining, that is another concern altogether. Instead of capital gains or personal income, this would likely be business income. With that said, there are different issues that may come with reporting income from crypto mining (more on that later).

The IRS will ask

One sign that the IRS is starting to track cryptocurrency income is that it is explicitly asking taxpayers on Form 1040 if they engaged in any crypto activities. The form asks if you received, sold, sent, exchanged or otherwise acquired an interest in any virtual currency. This might seem like a small thing, but it has big implications.

Most notably, the IRS seeks to obtain a truthful answer regarding such forms of income. If you lie, it can have serious consequences that go beyond simple tax compliance issues. The statements you make in your tax returns are made under the potential for a penalty of perjury. If you lie when answering this question, you could be subject to fines or other penalties.

However, the IRS guidance is that you do not have to mark “Yes” if the only type of transaction you have made has been to purchase cryptocurrency with dollars. That said, you will need to keep records of those transactions to record your cost basis for if and when you do make other types of transactions with the cryptocurrency you bought.

Crypto mining has unique tax issues

The income from mining crypto is different from income that might be gained from investing. Instead of a capital gain, mining income is treated more like business income — meaning you would be taxed on the profits. 

If you are running a crypto mining business, the fair market value of each coin mined would be considered revenue. As a business, you can also deduct certain costs that go into generating revenue. For example, you might be able to take a write-off for the costs of mining equipment.

However, just because you are mining, that does not make the activity a business. Joining a mining pool to make a little money may not count as a business. Instead, this could be considered hobby income. In this case, the tax implications are different. One important difference is that you cannot deduct hobby expenses from hobby income to reduce your tax liability.

Capital losses and charity payments can reduce liability 

Nobody wants to lose money when they trade, but it can be one way to reduce cryptocurrency taxes. Similar to stocks and other more conventional investment instruments, you can take a deduction for capital losses.

If you have capital losses, you can offset some of the capital gains by reporting them on your tax return. This is a case where cryptocurrency tax laws can be beneficial. As a crypto investor, you can claim up to $3,000 per year in capital losses. If your losses in a given year exceed $3,000, you can carry the remainder over to future tax returns to count against gains you might make.

Additionally, making donations to charities with cryptocurrencies can also help you reduce taxable income — in addition to supporting a cause that is dear to your heart. However, there are limits to how much can ultimately be deducted from your income.

Some transactions are not taxable

It might seem like there is a cryptocurrency tax for everything, but there are a few exceptions. While you do have to pay taxes on personal income, capital gains and business income from crypto, there is a short list of transactions that will not incur a tax liability.

As was mentioned before, a simple purchase of cryptocurrency with dollars is not taxable. However, it does have tax implications. You will eventually need to report the purchase if you ever sell, trade or use the crypto coins you bought.

Moving your coins from one exchange to another, or between wallets, is not taxable. You already own the coins, and you are not selling them for a profit just by moving them to a new exchange. That means you do not need to report the simple moving of coins between exchanges or wallets.

If you receive a cryptocurrency gift, there is no tax on that. With that said, if the gift exceeds $15,000, then you do have to pay taxes on it. If you decide to sell a crypto gift valued at more than $15,000, you would use the same cost basis as the person who originally purchased the coins.

Giving a donation in cryptocurrency is another situation in which the transaction does not incur a tax. If you do donate cryptocurrency, you should record the transaction at the fair market value of the coins at the time of the donation.

How to pay crypto taxes

Now, with some of the issues concerning cryptocurrency taxation laws out of the way, we can look at the process of paying cryptocurrency taxes.

  1. First, you are going to need to report all of the relevant trades and transactions. This not only includes the 1099s you may have received from exchanges, it also includes any transaction involving a sale, exchange of one token for another, or use of coins for purchases.

  2. With all of the income reported, you will need to determine your capital gains or losses. This will involve subtracting the cost basis of the assets from the sale price (or value at the time of exchange).

  3. Fill out IRS Form 8949 to record all of the taxable transactions. You will then need to carry the totals from this form over to a 1040 Schedule D.

  4. If you have other forms of crypto income, you will need to add those to the tax return. 

  5. For cryptocurrency mining as a business, you will need to fill out a 1040 Schedule C and itemize any deductions. If you are mining as a hobby, you report it as “other income” on a 1040 Schedule 1.

  6. If you were paid for work in cryptocurrency, it would likely be considered self-employment income. That means you will be subject to self-employment taxes.

Cryptocurrency taxes can be simple for some people, but they can be confusing and complex depending on the types of transactions. In general, the more active you are, the more complicated crypto taxes get. Furthermore, actions that might seem simple can have significant tax implications. Simply buying a cup of coffee with Bitcoin (BTC) can have tax implications.

If you are running a business that operates using cryptocurrency, it might be beneficial to pay for the services of a tax professional who will be able to help navigate the more complex issues and keep you compliant. Regardless of whether you do hire a professional or not, you should keep detailed records of every trade and transaction.