With the incredible rise in value of cryptocurrencies recently, many people are now making a substantial gain on their investments and are starting to share their stories.
But one question that lurks in the background of these celebrations is the question of taxes.
We understand that there are taxes due, but to what level? How are these investments supposed to be treated? Does it need to reported at all?
Unfortunately, the IRS (US Government) has been very sparse with details on this matter. From the few statements they have released, we can begin to put a picture together on how certain activities are judged.
In this article, we hope to clarify some of these points to give you a better idea of your tax obligations.
Cryptocurrency Is Not a Tax Haven
If you take away one things from this article, let it be this: Cryptocurrencies cannot be used to avoid your tax obligations.
Because of the pseudo-anonymity of public addresses, you might be tempted to think that you never have to report this to the government, opting instead to keep it under the table.
Despite the government’s general silence on specific cryptocurrencies, they have been very clear: if you intentionally hide your cryptocurrency returns, it will be treated as tax evasion or worse.
If money is moved in and out of cryptocurrencies as a way to avoid paying taxes, the government will bring criminal charges against you and heavy fines for tax avoidance.
Cryptocurrency as a Payment Method (Including Mining Activities)
If you’re a law abiding citizen, you will want to self-report your gains to the US government. But based on the circumstances you received your cryptocurrency under, you will have to treat the assets differently.
If you’ve received your cryptocurrency as a form of payment, the IRS will subject you to the same rules and regulations as traditional forms of currency (despite stating clearly that it isn’t, oh bother).
For example, paying someone’s wages using BTC will not exempt them from withholding and other payroll obligations. In addition, the payee must disclose this payment to the US government for income tax purposes. This is known as ‘Payment in Kind’ and will be treated like receiving payment in USD.
Even in you’re a miner and getting paid by the network, this is considered a payment, and thus will need to be treated like a income.
Cryptocurrency as an Investment: Capital Gain or Ordinary Gain?
Many people are not receiving cryptocurrencies as a form of payment, but instead investing in cryptocurrency like you would invest in a stock. In this particular instance, cryptocurrencies are treated like a a capital asset.
If a cryptocurrency is invested in and you’ve made a profitable return, then your taxable amount is relatively straightforward. If you bought $500 worth of BTC and then sold it for $1000, you will recognize a gain of $500. That $500 gain is taxable and should be self-reported to the IRS.
However, this just takes into account your taxable amount and leaves open a very important question : Is your investment of cryptocurrency considered a Capital or Ordinary Gain? This question is important because difference in these two tax rates can be substantial.
There are two classifications of Capital Gains – short-term and long-term. Short-term capital gains are defined as investments that are bought and sold within a one year time frame. For example, if you bought Bitcoin in January of 2017 and sold it in May of 2017, your profit would be classified as a short-term capital gain and subjected to your ordinary tax rate, ie your personal income tax rate. If you’ve made a lot of profit, under this circumstance you will paying taxes on it like ordinary income.
However, if you bought your cryptocurrency over a year ago and then sold it, you get the ‘long-term’ capital gains rate (or just capital gains tax rate), which can be up to 19% lower than your ordinary tax rate. This substantial discount means that you get to keep more of your cryptocurrency profit when you self-report.
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IRS Notice on Cryptocurrencies: IRS Notice 2014-36
Capital Gains Tax Rate Rules: https://www.fool.com/retirement/2016/12/16/capital-gains-tax-rate-for-2017.aspx