Understanding taxes has become more and more complicated over the years. We all should invest in a fantastic accountant who keeps up with the evolving yearly and monthly changes to the U.S. tax code. When it comes to taxes on cryptocurrencies, what you’ll be responsible for depends on the type of crypto and what you did with it; if you’re mining crypto, if you sold crypto, or if you’re holding it long term. Read more for some general guidelines on how you will be paying taxes on crypto investment profits, crypto mining, and what to do about reporting the crypto you own today.
U.S. taxpayers will need to report their crypto on a 1040 in the 2021 tax season due April 15, 2022. The 2021 question is worded different than it was worded for 2020, asking taxpayers:
“At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?”
This question leads to taxable events, whereas in the past, the question was more general.
Taxable events can include:
- Capital gains (long term): Investing/buying cryptocurrencies, NFTs, and selling them after a year
- Capital gains (short term/income tax): Trading, mining, staking, swapping, arbitrage, lending, etc
Crypto owners will need to report any calculated gain as if it was a stock or other investment, self-reported on the 1040. All coin acquisitions must be reported, including “airdrops” or “hard forks” (when a cryptocurrency splits into multiple branches and creates a new coin).
If you are buying true crypto (Bitcoin or Ethereum), then you will need to prove intent of purchase and track if you received the crypto as a payment or if you bought the crypto as an investment.
If you are “mining” crypto, and this is the heart of the confusion, the gain is reported as both created income as “amount mined”, and as an investment for appreciation/depreciation.
All these are to be self-reported by the taxpayer. For more information, stay up to date on what the IRS is saying.
Regarding receipt of crypto, the FMV from the date that you receive the crypto as a currency for goods and services is considered bartered cash and treated as if someone paid in cash. From the time you receive the crypto to when you convert it to currency, the appreciation or depreciation of the asset that occurs is the same as holding an investment, and you will need to track and report gains and losses.
If you have crypto you received as a gift, check the current rules on the IRS website. Rocket Lawyer states:
Sheltering of income through the purchase of crypto is another hot topic.
According to my US-based accountant, “The IRS asks us if our clients are dealing in crypto trade (the act of mining, receiving crypto as a currency of barter trade, or as an investment), and if clients are maintaining accounts in crypto. The US Treasury/IRS at this point is treating all reported gains as self-reported by the taxpayer (as there is no industry standard for the various taxing properties of crypto), and check this to acknowledge if crypto accounts are being maintained. Once some standard is set, there will be revisions to previous reporting of crypto income.”
If you’re interested in some more in-depth considerations of how to reduce your tax bill with crypto, check out this information on DeFi. Here is a link to their guide.
DeFi is “decentralized finance” which includes trading, buying, borrowing, and lending crypto. According to the IRS, when you sell or swap crypto, any proceeds are taxed as capital gains unless the result was a loss, which would then be reported as capital loss. Crypto earned directly is ordinary income according to the IRS. The link I provided will break it all down better and include a good overall guide on taxes on interest and staking rewards, governance tokens, rebasing tokens, wrapped tokens, transfers into and out of liquidity pools, multichain bridging, and crypto loans.
For example, if you take a look at Wonderland and their Time token, when you stake it, you get taxed via every rebase event which happens once every 8 hours, so you create a taxable event 3 times per day. With no tracking software, you literally have to track it manually on a spreadsheet. This is where wrapped tokens come in handy; instead of creating 3x taxable events, you can ‘wrap’ the Time token and convert it into Memo, which is now containerized. To do this makes the asset increase in value within a wrapped token, as opposed to the token accruing in quantity.
It’s important to state that the guidelines for this type of activity aren’t set in stone, so it is still another gray area. However, as someone who profits from crypto, you are held responsible for reporting your income/gains and paying taxes on them – even though there are no clear IRS guidelines. Catch 22? Yes!
Most CPAs and tax professionals will default to the safe route – report everything on every gain/income. But as the articles below indicate, people may be paying the government taxes without proper guidance.
Here is an example via the case with Josh Jarrett that challenges DOJ/IRS considerations of crypto as property:
https://fortune.com/2021/05/26/crypto-taxes-tax-rules-cryptocurrency-irs-joshua-jarrett/
Here is an update on the case where it appears the DOJ is backpedaling their original statements:
What does all of this mean? We still need clarity from the DOJ/IRS. The IRS interprets the laws laid out by the DOJ, but because the DOJ is unclear, the tax laws are still in the gray area in some cases, such as staking.
But since you will need to begin to prepare to keep your own accounting notes, there is a crypto tracking software that a lot of YouTubers use which is mentioned in these videos below:
Bitcoin Tax: http://bitcoin.tax/clearvaluetax
Crypto Trade: http://cryptotrader.tax?fpr=46b4e
Token Tax: https://tokentax.co?via=clearvaluetax
Take all of this information with a grain of salt, as the IRS is updating their regulations regularly and we still don’t know a lot about what will happen with crypto and taxes in the future. The best best is to do your own research and hire a good accountant. I’ve found over the years that the best accountants aren’t the most affordable ones, and you will need to pay for a good one who will spend the time and effort to keep up with what’s going on in this space as well as all the other nuances of your business, income, and personal finances. It can end up being a wash to pay the fee for a great accountant, especially if, by accurately following all the new rules of reporting, you avoid paying too much in taxes.
IRS Virtual Currency Guidance
The IRS issued IRS Notice 2014-21, IRB 2014-16, as guidance for individuals and businesses on the tax treatment of transactions using virtual currencies.
Overall, the most important thing to keep in mind is that it is your job, with the help of your accountant, to keep up to date on what the IRS is saying. It’s also important that the accountant you add to your team is knowledgeable about crypto currencies. Be aware of any changes since they happen regularly. This post was written with Ironsung on Fiverr, and we have been working on this since December 2021 while watching all the changes and updates over the recent months. We can offer this as a preliminary guide, but do keep in mind that we aren’t tax professionals or accountants. Please always consult a professional. We are just here to share a bit of the information we have compiled, so do your due diligence, and don’t take any of this article as legal or tax advice.
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I hope you have a smooth tax season. Subscribe for more business, sales, and investing posts. Have a lovely day!
