Tax laws

What U.S. Taxpayers Need to Know as Tax Day Approaches

By Seth Wilks, Director of Government Relations

Did you trade or sell Bitcoin, Ether or other digital currencies in 2020? If so, you will have information that you must report on your tax return. With the tax deadline fast approaching, TaxBit’s CPAs and tax attorneys break down cryptocurrency tax laws to make this process as easy as possible. Contrary to popular belief, crypto taxes don’t always mean bad news. If you sold crypto at a loss or donated or gifted crypto in 2020, you may be able to reduce your tax liability.

Let’s start with the basics.

Do you pay taxes on cryptocurrency?

Yes, you pay tax on cryptocurrency gains when you own an asset, much like stocks. This can include: selling your crypto for cash, exchanging one cryptocurrency for another, or using crypto as payment. You may also pay taxes on cryptocurrency earned as income through mining, staking, or paying in crypto.

And the IRS is serious about enforcing that. This year, for the first time, the IRS added a new question to Form 1040 that asks taxpayers: “At any time in 2020, did you receive, sell, send, exchange, or otherwise acquire a financial interest in a currency Virtual ?
If you fail to report your crypto taxes, the IRS may prove intentional disregard for knowingly failing to report it.

However, not all crypto activities receive the same tax treatment, and this is where things can get confusing for crypto investors. To clarify, let’s take a look at how cryptocurrency is taxed and how these tax laws apply to some of the more common crypto activities.

What are the tax rates for cryptocurrencies?

If you received cryptocurrency as income, it will be taxed at your ordinary income rate. If you have cryptocurrency, however, any profits will be taxed at the capital gains tax rate, which varies depending on how long you’ve held the asset and your earnings.

If you held crypto for more than a year before selling, your capital gains will be taxed at the long-term capital gains rates shown in the table below.

2020 long-term capital gains tax rates

Tax rate

Income – Single

Income – Married filing jointly

Income – Head of Household

0%

$0 – $40,000

$0 – $80,000

$0 – $53,600

15%

$40,001 – $441,450

$80,001 – $496,600

$53,601 – $469,050

20%

$441,451 +

$496,601+

$469,051 +

Alternatively, if you sold crypto after holding it for less than a year, those gains will be taxed at short-term capital gains rates, which equals your ordinary income rate in the table below.

2020 Short Term Capital Gains Tax Rates

Tax rate

Income – Single

Income – Married filing jointly

Income – Head of household

ten%

$0 – $9,875

$0 – $19,750

$0 – $14,100

12%

$9,876 – $40,125

$19,751 – $80,250

$14,101 – $53,700

22%

$40,126 – $85,525

$80,251 – $171,050

$53,701 – $85,500

24%

$85,526 – $163,300

$171,051 – $326,600

$85,501 – $163,300

32%

$163,301 – $207,350

$326,601 – $414,700

$163,301 – $207,350

35%

$207,351 – $518,400

$414,701 – $622,050

$207,351 – $518,400

37%

$518,401+

$622,051+

$518,401+

Common crypto activities and how they are taxed

Good news for all crypto-hodlers! The purchase of Bitcoin or other cryptocurrencies is not in itself a taxable event. You only pay taxes on this crypto when you dispose of it (trade, sell, or use as a means of purchase). However, it is still important to keep track of this activity as it defines your cost base when dumping your crypto.

Sell ​​crypto for fiat

Selling crypto for fiat currency is taxable as property, which means any gain will incur capital gains tax. You will need to report your capital gains and losses on IRS 8949. For example, if you buy $2,000 worth of ETH (this is your cost basis) and later sell it for $2,500, you will incur a gain in capital of $500.

Crypto to crypto exchange

Exchanging one coin for another is again taxable as property and will need to be reported on your IRS Form 8949. For this example, let’s say you bought 2 Litecoin for $500 (this is your cost basis ). Later that year, you traded all that Litecoin for ETH. When you made this transaction Litecoin had increased in value and the new value of 2 Litecoin was $750. You would have realized a capital gain of $250.

It is important to note that if you were just to transfer coins from one exchange or wallet to another, it is not a disposition and therefore not taxable.

Use cryptography to buy goods or services

Using crypto as payment for goods and services constitutes an assignment and any gain or loss will need to be reported on Form 8949. Note that this includes all purchases made on cryptocurrency debit cards!

Mining or staking cryptocurrency

Any crypto earned through crypto mining or staking is taxable as income. Unlike the examples above, all profits here will be subject to ordinary income tax rates, not the capital gains tax rate. The amount taxed will be equal to the fair market value of the asset at the time the coin is mined, not sold.

Note that if you then sold that crypto, it would trigger a second taxable event and you would be required to report that capital gain or loss on Form 8949.

Airdrops and hard forks

Any crypto received from an airdrop, resulting from a hard fork or other reason, is taxed at the ordinary income rate. The amount taxed is the fair market value of the crypto at the time it was received.

Get paid in crypto

Like cryptocurrency mining or staking, any money earned by being paid in crypto is taxable as income and must be reported on Form 1040.

What about crypto losses?

Cryptocurrency losses must be reported on your IRS 8949, just like cryptocurrency gains. There’s a silver lining here, though. If you disposed of your crypto with a capital loss, you can use that loss to offset your capital gains or claim the capital loss deduction.

With the capital loss deduction, you can deduct up to $3,000 in capital losses per year. And, if you had more than $3,000 in net capital losses, you can carry that amount forward to future years to offset capital gains or reclaim the capital loss deduction.

Cryptocurrency gifts and donations

More good news! Donating or gifting cryptocurrency are not taxable events, so you will not recognize any gain or loss on a gift or donation.

Additionally, if you have held the cryptocurrency for more than a year prior to donating, then you will be eligible for the itemized charitable deduction for the fair market value of the cryptocurrency at the time of the contribution.

If you donate after holding the cryptocurrency for less than a year, you are still eligible for the itemized charitable deduction, but your deduction will be limited to the amount you obtained the crypto for (your cost basis).

It is important to note that the deduction only applies to donations to a qualifying charity. Other gifts, such as a graduation gift or crypto crowdfunding, are not eligible for the deduction.

NFT

In most cases, NFTs (non-fungible tokens) are subject to the same tax laws as fungible cryptocurrencies. If you’re an artist who made money selling an NFT, that amount will need to be reported as income on your tax return. And if you invest in NFTs, any profits made through sales or trades will be taxed as property and subject to capital gains tax.

Keep these most common activities in mind when filing your tax return:

  • If you purchased an NFT using a fungible crypto token like Bitcoin or Ether, you will need to report your capital gains (or losses) from selling crypto

  • If you sold an NFT for another NFT, you must report capital gains or losses

  • If you sold an NFT for a fungible crypto asset, you must report capital gains or losses

Quick tips to save tax on cryptos:

As you probably understood above, cryptocurrency taxes can be convoluted, especially for those with a lot of transactions. However, when you understand the crypto tax laws, you can identify ways in which the laws provide tax savings. Here are some tips you can apply now, and throughout the year, to save money on your crypto taxes:

  • Donate and gift valued crypto assets to avoid capital gains tax (and for donations, claim the charitable tax deduction!)

  • Claim the crypto capital loss deduction up to $3,000 per year (and carry forward any losses over $3,000 to future years)

  • The wash sale rules do not apply to crypto, so sell your crypto assets in a loss position and buy them back to offset any capital gains.

Get the Guide to Harvesting Tax Losses on Cryptocurrency Trading to learn more about how to do smart things to minimize your taxes.

If you delay your crypto taxes out of fear or uncertainty, TaxBit is here to help. Founded by CPAs and tax attorneys, TaxBit automates all aspects of crypto tax reporting from start to finish. Start now with 10% off.

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