Ever since the emergence of Bitcoin (BTC), a lot of people turned to cryptocurrency as a reliable source of income. For a few years, there was no need to tax cryptocurrency earnings, but as expected, that didn’t last long.
From 2014 onwards, government agencies, particularly the Internal Revenue Service (IRS), began to address cryptocurrency for taxation. At the moment, cryptocurrency is treated the same as most assets.
However, due to cryptocurrency being relatively new to the market, the IRS has yet to create a taxing procedure for the said asset. Despite the lack of standard procedure, the IRS still requires investors and traders to report any cryptocurrency earnings.
But as they say, knowledge is power. Learning how the tax calculations work would most definitely go a long way in helping you cut down on taxes and further increase your earnings.
On that note, below are five things you need to know about cryptocurrency taxes:
1) Cryptocurrency Taxes Can Be Either One Of Two Types
Currently, the IRS treats cryptocurrency earnings as either business income or capital gain, depending on how you acquired the earning. Here’s a closer look at what each type entails:
- Business/Corporate Income Tax
Business income refers to earnings made when a party exchanges their goods or services for the crypto. For example, if your business accepts crypto payments, any cryptocurrency you receive would count as business income. The same goes for when you receive crypto when working for an employer. For your reference, the average corporate income tax rate in the United States in 2021 is currently at 24%.
- Capital Gains Tax
Meanwhile, capital gains refer to earnings made as a result of buying an asset and selling it at a higher price. For example, if you bought one Bitcoin in December 2017, you would’ve spent around USD$20,000 for the transaction. If you then sold it three years later, in December 2020, you could sell it for approximately USD$40,000. The difference between the two, which is USD$20,000, is referred to as capital gains.
Currently, the US capital gains tax rate may vary from 0% to 37%, depending on whether it’s long-term or short-term. Long-term capital gains refer to profits made by selling assets held for over one year, and it has the lower tax rate of the two. For that reason, most investors wait until they’ve kept their crypto assets for a year before selling.
2) Crypto Earnings Can Qualify for Capital Loss or Ordinary Loss
As you may already know, when you suffer from a loss, whether from a business transaction or an investment, you can deduct that loss from your taxes. The same applies to cryptocurrency.
Using the previous example, if you bought not one but two Bitcoin in 2017 for USD$20,000 each but then sold one in June 2020 for more or less USD$10,000, you’ll net a capital loss of USD$10,000 on that transaction. You can then use this capital loss to reduce your taxable capital gain of USD$20,000 from the other Bitcoin you held until December 2020.
Similarly, if your business suffers from a loss, you can capitalize on your losses. This particular tactic is well-known among investors and business owners alike. Speaking of which, if you’d like to know similar money-saving tips, you might be able to find more from FinTech blogs.
3) Holding Or Possessing Crypto Won’t Lead to Taxes
Many people assume that by simply possessing crypto, they’re slowly incurring taxes. However, the only way for you to incur cryptocurrency taxes is when it undergoes disposition.
Disposition refers to the process of getting rid of an asset, be it through selling, transferring, or giving. Unless you do any of the following procedures, you don’t have to worry about taxes:
- Gift cryptocurrency
- Buy or sell cryptocurrency
- Buy goods and services with cryptocurrency
- Provide goods and services for cryptocurrency
- Convert cryptocurrency to US dollars
4) Trading One Type of Crypto to Another Is Taxable
Similarly, some people think that trading one type of cryptocurrency for another isn’t considered a disposition and is therefore untaxable. However, in reality, this act is taxable since you’re essentially buying or selling an asset. For example, if you exchange one Bitcoin for 264 Litecoin in 2021, you’re effectively selling Bitcoin and buying Litecoin simultaneously, which is technically a type of disposition, as stated earlier.
5) You Must Keep Records on Transactions Involving Crypto
When managing a business, owners are obliged to keep records of their transactions. These may include expenses and customer payments. Similarly, if you’re running a business that accepts crypto payments, you must keep the records on each transaction. However, it’s more complicated than the previous case, as you’ll have to include other types of information, such as:
- The value of the crypto in US dollars at the time of its disposition
- The crypto wallet addresses
- The software costs for the transaction
While many people downplay the importance of being ‘tax-knowledgeable,’ it can prove extremely useful in the long run. Not only does it significantly reduce the possibility of making errors, which can be catastrophic, it also allows you to figure out ways to cut down on taxes. The IRS might not have a standard procedure at the moment; you should be able to make use of the information in this article to concoct a plan to maximize your cryptocurrency earnings.