Yes, in the United States you have to pay taxes on Bitcoin and cryptocurrencies. Cryptocurrency taxes are generally levied by the IRS in five different ways: property exchange, income, mining, capital gains, and dividends/interests.
Before going into details, let’s first clear some of the basic concepts associated with Bitcoin and other cryptocurrencies. This will help you understand clearly why and how different taxes are imposed by the IRS on Bitcoin and other cryptocurrencies.
Bitcoin is a digital currency that uses a cryptographic encryption system for facilitating secure transfers and storage. Bitcoin and other cryptocurrencies are neither printed by a central bank nor is backed by any government or central agency. That’s what makes the cryptos so special.
These decentralized cryptocurrencies can also be used to buy services, just like a fiat currency/money (such as US Dollar). The Bitcoins are listed on crypto exchanges and paired with other leading currencies in the world like US Dollar (USD) and Euro (EUR) for trading. You can trade Bitcoin against the US Dollar (BTC/USD pair) and others.
Bitcoins are not minted as their fiat counterparts. A process involving high-powered computers, a distributed network, and an open-source mathematical formula are used for mining or producing Bitcoins.
Yes, taxes are applicable on cryptos.
The growing importance of Bitcoin is acknowledged by the US Treasury. That’s why they have announced that transactions and investments related to Bitcoin can’t be regarded as illegal.
At the beginning, the attractiveness of Bitcoin was that it was unregulated and many people thought that they could use their cryptocurrency transactions for avoiding their tax obligations. In fact, initially it was tougher for the authorities to keep track of the cross-country transactions because of Bitcoin’s virtual nature and universality.
As popularity and daily transactions of Bitcoin increased, government authorities across the globe soon realized that black marketers had started investing in Bitcoin and were consequently making illegal deals. That’s why tax authorities around the world are trying to bring regulations on Bitcoin.
The US government alerted its tax authorities and now no one can escape their radars. If you think that you can avoid taxes by trading Bitcoin, you are mistaken. The U.S. Internal Revenue Service (IRS) and its counterparts in other countries treat Bitcoin in the same way and have either brought or are bringing regulations on Bitcoin and other cryptocurrencies.
The tax authority in the United States, Internal Revenue Service (IRS), considers Bitcoin (BTC) as an asset and not a currency simply because it isn’t issued by a central bank. The tax implications become clear when the cryptocurrencies are treated as asset class.
Back in July 2019, the federal agency said that they were sending warning letters to over ten thousand taxpayers who they suspect had “potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.” The tax authority made it clear that any incorrect income reporting would attract penalties, interest, or even criminal prosecution from them.
The U.S. Internal Revenue Service has made it mandatory for taxpayers to report all kinds of Bitcoin and cryptocurrency transactions to them, no matter how small the value may be. That’s why the tax authority wants you to keep a record of everything you do with Bitcoin and other cryptos including buying, selling, investing, and using Bitcoins or other altcoins for paying for goods/services.
The IRS has started to take Bitcoin and other cryptocurrencies most seriously in the last 5-years. There are still many unanswered questions about Bitcoin and other cryptocurrencies, especially regarding offshore and international Cryptocurrency aspects in the Revenue Rule 2019-24 and Notice 2014-21.
In fact, there have been many things that we have seen recently such as:
The IRS wants to recover the estimated billions of US dollars that they are missing out on because the taxpayers are allegedly not complying with the crypto tax laws/rules. That’s why they are ramping up enforcement.
There is still no definitive guidance from the IRS on all the issues involving cryptocurrency and US tax laws. In the last few years, the US tax authority has given some additional clarifications.
Keep on reading if you belong to any of the following cases:
No matter which case you belong to, you come under cryptocurrency tax rules if you have to deal with Bitcoins and other cryptos for capital gains, dividends/interests, mining, income, and property exchange. Now, let’s check the different cryptocurrency tax laws that you have to comply in case of different cases:
Revenue Ruling 2019-24 provides some insight into the taxation of cryptocurrencies. Two main issues have been presented by the ruling:
As per the Revenue Ruling 2019-24, hard fork will not result in taxable income. This is because the hard fork didn’t result in a taxable event.
In accordance with the hard fork, if a taxpayer receives airdrops of new cryptocurrency, those airdrops will be considered as gained and therefore will be considered as taxable income.
This scenario can be explained with the help of an example. Suppose, your friend owns a property, which you want to have. The Fair Market Value or FMV of the property is US$10,000.
Now, your friend reads about the prospect of Bitcoin and wants to have it. Let’s say you have US$8,500 worth of Bitcoin and other cryptocurrencies. Instead of buying Bitcoin from cryptocurrencies, he wants your Bitcoins in exchange for his property, whose FMV is US$10,000. He exchanges your US$8,500-worth of Bitcoin for his asset valued US$10,000.
The IRS will consider that you received US$10,000 worth of property but you put up just US$8,500. The federal agency will consider that you made US$1,500 (i.e. US$10,000 – US$8,500 = US$1,500). The carryover basis rules cannot be applied as this is not a gift. Though there was no exchange of money, the IRS will tax on the US$1,500 perceived gain you made out of that exchange. If you sell the property down the line then US$10,000 will be the basis.
If you have made a similar kind of property exchange deal with your crypto, always remain prepared for paying the taxes.
You have to report to the tax authorities about every cryptocurrency you receive as income. It will be considered as an ordinary income and therefore will be taxed accordingly.
In case, you are a consultant and you receive payment from your client in terms of cryptocurrency, it’ll be considered by the IRS as self-employment income on your tax return. The employer will deduct the expenses of paying you as an expense and not as a sale.
Crypto tax is levied differently for miners: as hobbyists and business miners. Now, let’s check the tax implications for both kinds of miners.
When you are mining Bitcoins, you do it with the hope that you’ll receive a reward for performing the works and completing the verifications. However, the payout is not guaranteed. That’s why there are two kinds of taxes for:
The income you make will have to be written in the other income section of the Form 1040 Schedule 1 (Additional Income and Adjustments to Income). All the expenses of mining will have to be written on a Schedule A (Itemized Deductions), miscellaneous subject to 2% of AGI limitation (only applies to 2017 and prior years).
In case of business miners, income as well as expenses are listed on Schedule C (Profit or Loss from Business) or on applicable business returns (Form 1065, Form 1120, Form 1120S).
Income generated from crypto mining will be subjected to the self-employment tax of 15.3%.
To offset mining income, business related expenses can be deducted.
The income generated from Bitcoin and other cryptocurrencies will oftentimes come under capital gains. Let’s check when your crypto income will be considered as capital gains.
Suppose, you bought US$80,000-worth of cryptocurrency sometimes back. Now, it’s worth has become US$600,000. If you sell it now, it will earn you a gain of US$520,000.
IRS (Internal Revenue Service) considers Bitcoin as an asset and not a currency. This US government tax agency expects its taxpayers to report about Bitcoin transactions for tax purposes. Two types of taxes are levied on cryptocurrency transactions:
If your cryptocurrency is pooled in a fund generating dividends, interest, or capital gains, it’ll be taxed as per its character. In case, your pooled cryptocurrency fund is in a foreign fund, potential PFIC (Passive Foreign Investment Company) tax treatment may take place.
Despite all the above mentioned clauses, cryptocurrency taxation is not that simple. Determining the fair value of the crypto on purchase and sale transactions is difficult. This is because Bitcoin is highly volatile. Huge swings in prices can take place in a single trading day. That’s why the IRS encourages you to maintain consistency in reporting.
Suppose, you are considering the day’s high price for purchases. In that case, you should use the day’s high price for sales too. If you are a frequent trader or investor in the cryptocurrency market, to reduce your tax obligations, you can use “first-in, first-out” (FIFO) or “last-in, first-out” (LIFO) accounting techniques.
2021 is the right time to invest in cryptocurrencies because
1. JPMorgan Analysts believe that investors have started considering Bitcoin as a better store of value than gold. They believe billions of dollars worth of investment can potentially flow from gold to Bitcoin. As more and more institutional investors move their capital from gold to Bitcoin, the price will go up exponentially.
2. Reports say that the pension funds and life insurance companies are going to invest around US$600-billion (equivalent to the current total global crypto market capitalization) in Bitcoin and other cryptocurrencies in the coming years, especially in 2021.
3. Institutional investors have started parking their capital in Bitcoin and are buying heavily at every low. Cointelegraph Markets analyst Michaël van de Poppe and many others believe that big investors such as Paypal, Square, Grayscale, MicroStrategy, and many others are buying at lower levels as the small crypto “traders, shitcoiners, and weak hands” sell-off. Recent Chainanalysis data has confirmed that institutional bitcoin investors are leading the price rally in 2020.
4. In 2020, the Bitcoin price against the US Dollar (BTC/USD) has increased by 300%. Chainanalysis data has confirmed that this massive surge in price has happened because of the continued buying by the big and institutional investors. If you invested US$1,000 at the beginning of 2020 and held the bought Bitcoins for the entire year then the value of your held Bitcoin would have been US$3,000 now, a 3-times increase in profit.
5. If you consider the ROI since the beginning of 2017, Bitcoin’s price has increased by almost 3,000% till the end of December 2020. At the beginning of 2017, each Bitcoin coin’s price was US$1,000, which has now (till 2020-end) increased to just below US$29,500. Though there has been a price crash in 2018 from the US$19,500 level to the US$3,500 level within a year’s time, the time has changed now.
6. Crypto experts believe that the BTC/USD price will explode and will reach the US$200,000-300,000 region by the end of 2021.
7. Ali Mizani’s (Founder of FiCAS AG) estimate is particularly important here because he had rightly predicted Bitcoin’s bull runs in 2016, 2017, and 2020. He has said that by the end of December 2021 to March 2022, he expects the BTC/USD pair to reach around US$200,000-US$300,000.
8. Scott Minerd, the chief investment officer of Guggenheim Investments, believes Bitcoin’s worth will be US$400,000.
9. The Bitcoin price is expected to rise to $50,000 by 2021-end, Nexo co-founder Antoni Trenchev has said.
10. A well-known chartist, Alan Masters, has said that the bull run has the potential to push the Bitcoin price up to US$73,000 next year. He has called each of the TD Sequential cycles since March 2020 as a “real deal” and went on to say that its historical accuracy will at least push the BTC/USD pair towards the US$44,000-46,000 zone.
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