- Crypto mining creates ordinary income equal to the fair market value of the cryptocurrency on the day received — any subsequent change in value causes capital gain or loss when the miner sells the crypto
- If you use multiple exchanges or wallets and commonly transfer assets between these various platforms, the tax information you get from these platforms in the form of a 1099 might be wrong
US citizens are required to pay taxes on crypto and all digital assets — and will continue to, no matter how we change its classification. With plans in recent proposed legislation to expand the number of IRS agents and reporting requirements, it is clear the regulator is cracking down.
Failure to properly report and pay tax on cryptocurrency transactions can lead to interest, penalties and potential criminal charges, especially as the IRS ramps up enforcement around digital assets. With help from Ledgible, the leading professional-first crypto tax and accounting software company, we hope to ease some of that burden. We will highlight important tax planning considerations, provide the latest IRS guidance and offer updates on potential legislative tax code changes.
How is crypto taxed?
The IRS taxes cryptocurrency as property, which means most of the time it applies a capital gains tax. Regardless of exception, it is important to understand that a crypto sale always triggers a taxable event. The IRS requires that you report any gains, even if it is made in an alternative digital asset.
Notably, however, current IRS guidance around cryptocurrency is lacking, as the agency has held off on detailing the exact tax scenarios of specific crypto trades, but regulation is coming. Both the Infrastructure Act and the Inflation Reduction Act contain provisions around digital assets that are sure to shift the tax reporting landscape as the industry matures.
In Notice 2014-21, the IRS explained that investor intent is the main reason why it considers crypto property. It says that because no jurisdiction has adopted it as legal tender, they only see price speculation as the reason for purchasing crypto.
But in 2021, El Salvador officially adopted bitcoin as legal tender, followed by the Central African Republic in 2022. Some argue that this trend could call the IRS’ treatment of cryptocurrency as property into question. But classifying crypto as currency may not be in the token holder’s interest. Internal Revenue Code (IRC) Section 988 treats gains or losses from foreign currency transactions as ordinary income. So a change in classification would therefore result in far higher tax rates.
Since April 2022, three separate bills introduced to Congress — the Digital Commodity Exchange Act of 2022, the Responsible Financial Innovation Act and the Digital Commodities Consumer Protection Act of 2022 — would make the Commodity Futures Trading Commission (CFTC) the primary regulator of cryptocurrency spot markets. This could cause the IRS to treat cryptocurrency as a commodity.
For most investors, gains on the sale of commodities contracts are treated as 60% long-term capital gains and 40% short-term capital gains. “Mark-to-market” rules for commodities contracts also recognize gain and loss on open contracts at the end of the year.
However, even if cryptocurrency becomes treated as a commodity, coins themselves would likely not constitute a commodities contract. For example, bitcoin (BTC) would qualify for capital gains treatment as a commodity, but the 60-40 and mark-to-market rules would likely only apply to bitcoin futures contracts.
IRS guidelines for the US
As noted before, the IRS has issued little guidance on cryptocurrency taxation. Notice 2014-21 describes the basic tax treatment of virtual currency and contains a brief FAQ.
The IRS also maintains a more detailed virtual currency FAQ on its website. However, this FAQ does not bind the IRS or protect the taxpayer from penalties.
With so little guidance on crucial tax issues, investors, businesses and CPAs need the expertise of a crypto tax specialist. In fact, cryptocurrency investors have already taken the IRS to court over staking rules and won, causing some crypto tax tracking platforms to make changes to their staking categorization rules.
Tax guidelines outside the US
Crypto tax guidelines outside the US vary widely. Countries such as China, Algeria and Egypt have banned cryptocurrency altogether, while Belarus, El Salvador, Singapore, Malaysia and Georgia allow mostly tax-free cryptocurrency trading. Crypto held for more than a year in Germany incurs no tax, but France levies punishing taxes on cryptocurrency gains. Japan taxes crypto gains as ordinary income rather than capital gains.
Countries where there are no taxes on crypto
While the US and other large economies like the UK and China are continuing to crack down on crypto trading, some countries have positioned themselves as tax havens for crypto traders. Particularly, some countries require traders to pay zero taxes on the transaction. The top 10 leading crypto tax-free countries are:
- El Salvador
- Cayman Islands
- Puerto Rico
All of these countries either have a 0% crypto tax rate or have rules and regulations surrounding crypto that allow users to pay essentially zero taxes in most scenarios. However, if you don’t find yourself in one of these tax havens, nor do you have plans to move, then crypto taxes are likely a reality for you.
When do you pay taxes on cryptocurrency?
Cryptocurrency investors incur capital gains tax when they sell cryptocurrency. And they pay tax on crypto gains when they file that year’s tax return or make quarterly estimated tax payments. In addition to this, businesses and institutions that hold or trade crypto have to track the assets on their balance sheet and pay taxes on their gains as well.
Crypto sales (disposal of assets)
Crypto capital gains primarily occur due to a sale or a disposal of the asset. Exchanges count as sales — including trading one crypto for another. An investor who trades bitcoin they’ve accumulated since 2015 for ether would have to comb through seven years of transactions — unless their cryptocurrency tax software does it automatically.
It’s also important to note that if you use multiple exchanges or wallets and commonly transfer assets between these various platforms, the tax information you do get from these platforms in the form of a 1099 might be wrong. Because each platform only has access to data from their own platform, they can’t accurately calculate your tax information for crypto assets that have moved between exchanges, wallets or platforms. This necessitates the use of a crypto tax tracking platform to aggregate, normalize and make all of this data eligible for tax filing.
Cost basis (see below) exceeding a crypto’s sale price causes a capital loss for investors. For individuals, capital losses can offset capital gains from traditional assets and crypto as well as up to $3,000 of ordinary income. Any unused loss carries forward indefinitely to subsequent years. C corporations may only use capital losses to offset capital gains, then carry any excess loss back for three years and forward for five years.
According to the IRS, you can claim a capital loss from selling cryptocurrency by reporting it on Form 8949, then Schedule D of the individual or corporate tax return. While this may sound simple, properly creating an accurate 8949 form for cryptoassets come tax time is easier said than done.
The Wash Sale Rule (and how it applies to cryptocurrency)
The wash sale rule disallows deducting the loss on a security sale if the investor acquired substantially identical securities (or related options) within 30 days of the sale.
For example, say you buy shares in the Schwab Total Stock Market Index and the price drops. If you decide to buy shares in the Vanguard Total Stock Market Index within 30 days, you can’t deduct the loss in your taxes. If an investor were to make a similar trade, they would want to add the disallowed loss to the basis of the identical security to avoid paying a higher capital gains tax in the future.
The wash sale rule interferes with tax loss harvesting — deliberately realizing capital losses to offset capital gains. But it does not apply to cryptocurrency because the IRS considers crypto as property rather than securities. Any legislation that changes crypto’s tax status to a security would cause the wash sale rule to apply. Some proposed bills, including President Biden’s Build Back Better Act, would directly close this loophole, however, lines in recent legislation regarding expanding the wash sale rule to crypto were removed, signaling the rule is here to stay for now. Most recently, the expansion of the wash sale rule to crypto made it into a draft of the Inflation Reduction Act, but the provision was cut in the bill that passed both the Senate and House.
Tax loss harvesting
With the wash sale rule and its lack of application to crypto here to stay for now, crypto investors can take advantage of tax loss harvesting strategies for crypto. This essentially means that active crypto traders can book their losses, harvest the loss and immediately buy back into the crypto. What this allows is traders to maintain their same exposure to the cryptoasset for future gains, but book the capital losses onto their current tax year, essentially pushing their tax burden down the line to future tax years.
How to track gains and losses
To calculate a capital gain or loss on a cryptocurrency, you subtract the cost basis from the sale proceeds. Cost basis is simply the fair market value of the crypto when the investor originally acquired it, including transaction fees. The formula for crypto cost-basis is:
(Crypto Purchase Price + Fees) / Quantity
Every individual crypto purchase, even of the same token, has its own cost basis. This makes detailed tracking vital. Without detailed records, the IRS defaults to the FIFO (first in, first out) method—assuming the first coins bought are also the first sold.
For example, say you bought 5 BTC at $20,000 in May and then 5 BTC at $40,000 in June. And then in August, you sold 3 BTC at $25,000. Under the FIFO method, the IRS will assume that the cost basis of those 3 BTC was $20,000.
However, according to Ledgible, the HIFO (highest cost basis in, first out) method may decrease current year tax by selling the highest cost basis coins first. If you used this method of accounting in the above example, the cost basis for the 3 BTC would be $40,000 — resulting in a capital loss of $20,000.
Legible notes that accounting for this gets complicated quickly, but that its automated transaction tracing and cost-basis calculation tool can help investors and CPAs save time and minimize legal tax burden. The IRS can also track crypto by forcing exchanges to report tax information, like through the proposed 1099-DA form, making compliance vital. This requirement is something Ledgible also supports institutions and exchanges with.
Purchasing goods and services with crypto
Buying goods and services with cryptocurrency usually results in a capital gain or loss, just like a sale. However, if the seller’s main business is selling cryptocurrency, these sales will be treated as ordinary income.
Multiple bills introduced in Congress, including the recent Virtual Currency Fairness Act, would exempt small purchases with crypto from capital gains tax.
Receiving cryptocurrency for providing goods or services results in wage or business income. Exchanging crypto for a personal asset (such as new furniture for a home) generates a personal capital gain or loss. But even though it’s required to report these gains, taxpayers can’t deduct personal capital losses.
Crypto mining and staking
Crypto mining creates ordinary income equal to the fair market value of the cryptocurrency on the day received. Any subsequent change in value causes capital gain or loss when the miner sells the crypto.
The IRS has attempted to apply the same principle to staking rewards, but currently faces a challenge in court that supposes that crypto staking can’t be counted as income until the assets are sold, or disposed of.
The Responsible Financial Innovation Act mentioned earlier would delay taxes on crypto mining and staking until the sale of the cryptocurrency.
A fork is essentially any change or upgrade to a blockchain protocol. However, because blockchains are decentralized, not every validator has to agree to a fork. If enough oppose a fork, the change can result in a hard fork that creates two versions of the blockchain. Anyone holding tokens prior to a hard fork will own the same number on both chains. This duplication though makes guidance difficult because token holders don’t do anything to receive the new tokens — and some aren’t always aware of the change.
But in Revenue Ruling 2019-24, the IRS states that hard forks create (ordinary) income if the investor receives units of a new cryptocurrency. Owners of bitcoin who received bitcoin cash due to the 2017 hard fork would have ordinary income equal to the fair market value of the bitcoin cash on the day received.
Trading or minting NFTs
Minting NFTs creates ordinary income equal to the sale price of the NFT.
NFT traders’ gain or loss equals the sale price minus the cost basis of the NFT. While the IRS has not issued NFT-specific guidance, most tax professionals classify NFTs as collectibles subject to a maximum 28% tax rate. Report collectibles gain on Form 8949 and line 18 of Schedule D.
How much tax do you pay on crypto?
Selling cryptocurrency held one year or less creates short-term capital gain or loss taxable at ordinary rates. Cryptocurrency held over one year generates long-term capital gain or loss taxable at a maximum 20% rate.
Long-term vs. short-term capital gains
Short-term capital gains receive less favorable tax treatment than long-term capital gains. Many cryptocurrency traders buy and sell so frequently that they only incur short-term capital gains, resulting in more tax liability.
2022 Short-Term Capital Gains (Ordinary) Tax Rates
|Single||$0 – $10,275||$10,276 – $41,775||$41,776 – $89,075||$89,076 – $170,050||$170,051 – $215,950||$215,951 – $539,900||$539,901+|
|Married Filing Jointly||$0 – $20,550||$20,551 – $83,550||$83,551 – $178,150||$178,151 – $340,100||$340,101 – $431,900||$431,901 – $647,850||$647,851+|
|Married Filing Separately||$0 – $10,275||$10,276 – $41,775||$41,776 – $89,075||$89,076 – $170,050||$170,051 – $215,950||$215,951 – $323,925||$323,926+|
|Head of Household||$0 – $14,650||$14,651 – $55,900||$55,901 – $89,050||$89,051 – $170,050||$170,051 – $215,950||$215,951 – $539,900||$539,901+|
2022 Long-Term Capital Gains Tax Rates
|Single||$0 – $41,675||$41,676 – $459,750||459,750+|
|Married Filing Jointly||$0 – $83,350||$83,351 – $517,200||$517,200+|
|Married Filing Separately||$0 – $41,675||$41,676 – $258,600||$258,600+|
|Head of Household||$0 – $55,800||$55,801 – $488,500||$488,500+|
Reporting crypto to the IRS
Cryptocurrency-related transactions have become a focal point for the IRS. Accurate reporting and recordkeeping can help ensure any potential audit goes smoothly.
According to Ledgible, it is important to keep transaction logs from exchanges and equivalent records from all off-exchange transactions. Exchanges typically send this data in Form 1099-K, 1099-MISC, or 1099-B.
The crypto tax and accounting platform said the IRS needs capital gains and losses from cryptocurrency reported on Form 8949, then schedule D, and finally line 7 of Form 1040. And any ordinary income from cryptocurrency (such as crypto mined) also goes on Form 1040. But it recommends working with a tax professional because tracking can be overwhelming and IRS guidance is still a gray area. That way, the professional can help answer any questions the IRS may ask down the road.
This content is sponsored by Ledgible.
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