Walking the Crypto Tax Tightrope in US
Co-Authored by Jaideep Singh, CEO of AI-powered, SaaS platform FlyFin, Luke Olson, CPA, and Sridevi Yathirajyam, EA, FlyFin.
Over the past year, investing in cryptoassets has been an unending wild roller coaster ride, with unexpected twists and turns. Most recently, investors have experienced exhilarating highs and plummeting lows. The Biden administration has issued an executive order, that seeks to create a framework of stricter and – some argue – more coherent regulations for the crypto sector. With annual tax filing deadlines around the corner for everyone, now is the time to prepare to shield your income from taxes and know how best to maximize your crypto gains and losses.
1. What basic steps should an occasional crypto trader (non-broker) keep in mind and follow for tax filing and cryptoasset gains or losses?
The Internal Revenue Service (IRS) considers cryptoasset holdings "property" for tax purposes, which means it is subject to capital gains tax rules.
For occasional traders or investors, crypto held for a year or less is subject to short-term gains rates and, held for more than a year, is subject to more favorable long-term capital gains rates.
If your losses exceed your gains, you can deduct up to USD 3,000 from your taxable income (for individual filers). If you had additional losses more than the maximum allowed, you can carry these losses forward and apply these deductions accordingly to future years.
If you mine crypto as a hobby, include the value of the coins earned as "other income" on Form 1040 Schedule 1.
Receiving interest income from crypto lending activities or liquidity pools is considered a form of taxable income and must be reported on your taxes, similar to mining and staking rewards.
2. If I am a 'day-trader' dabbling in crypto and I have gains, can I report them at year-end, or do I have to report them quarterly if I'm self-employed?
Trading crypto is very similar to trading stocks and other securities, so many of the same tax rules apply. Crypto traders must pay taxes on the profits they earn. Traders can also write off their trade as a capital loss if they lose money.
People who are self-employed or have significant earnings from investments and day trading may generate more income than can be covered from payroll withholding. You need to estimate your tax liability four times a year and then write a check for those amounts. Otherwise, you could face a penalty at the time of tax filing.
Section 179 allows a deduction for the entire purchase price of mining equipment in the year it was purchased.
Also, miners can claim deductions like office expenses, equipment repairs, equipment costs, electricity costs, pool fees, hosting fees, etc.
3. As Capitol Hill debates new rules for federal taxes on crypto, does it make sense for an average crypto holder to wait out the laws under debate? Or, should a tax filer proceed with itemizing their crypto earnings in early 2022?
Potentially, there is no impact on the taxes owed by the crypto holder; the debate is on the need to regulate crypto exchanges, which would benefit the crypto holder in tracking the crypto transactions. This would not make any difference in the tax implications as the IRS already treats virtual currency as property and is taxable as per capital gains tax rules. So, taxes are owed when crypto is sold or exchanged, similar to a stock or bond.
President Biden Signed the Infrastructure Bill Containing Crypto Broker Reporting Requirements Into Law, which contains:
Effective 2023, crypto brokers such as Coinbase will be required to record transactions, tracking them for customers and the IRS, similar to how stock and bond brokers currently do via tax form 1099-B. They'll have to disclose their customers' names, addresses, and phone numbers, the gross proceeds from sales, and any capital gains or losses. Also, businesses that receive payments of USD 10,000 or more in crypto must report the sender's identity to the government, mirroring a similar anti-money laundering rule for cash transactions of that amount.
4. What if some of the transactions I made purchasing crypto didn't provide me with a 1099 Form?
The Internal Revenue Code and regulations require taxpayers to maintain sufficient records to establish the positions taken on tax returns. You should therefore maintain records documenting receipts, sales, exchanges, or other dispositions of virtual currency and the fair market value of the virtual currency.
Even 1099-K shows the aggregate of how much you have transacted on a cryptocurrency exchange. But it does not report the basis or your total gains or losses. But this 1099-K is automatically sent to the IRS, so they have an idea of your activity on third-party exchanges.
The decentralized nature of the blockchain makes Bitcoin (BTC) and other cryptoassets exceptionally difficult to track and trace. A portfolio tracker should be a one-stop shop for all of your coins that offers connectivity with all coins and exchanges.
5. Here's a basic example or two that illustrates a taxable event?
Suppose one receives crypto in exchange for goods and services (wages or contract work) or mining virtual currency. In that case, the crypto received is treated as income and must be recorded and reported as the fair market value of the crypto received and counted as income on your tax return. However, mining crypto is usually considered a self-employment activity. This means there is a need to pay self-employment taxes in addition to ordinary income taxes.
When this income is reported, it is taxed at ordinary income tax rates that are higher than capital gains tax rates. The cost basis, which is the currency's initial value when received, is the amount to be reported as income.
When you eventually dispose of the crypto, this basis is used to calculate any capital gains and pay the applicable capital gains taxes.
6. What tax penalties might I face for not doing these things?
IRC 6721 provides a penalty for failure to file correct information returns.
IRC 6722 provides a penalty for failure to furnish correct payee statements.
IRC 6723 provides a penalty for failure to comply with other information reporting requirements.
The following penalty amounts are effective for returns and statements required to be filed:
- USD 50 per failure, not to exceed an annual maximum of USD 500,000 for returns filed correctly within 30 days of the due date.
- USD 100 per failure, not to exceed an annual maximum of USD 1,500,000 for returns filed correctly after 30 days, but on or before August 1, or
- USD 250 per failure, not to exceed an annual maximum of USD 3,000,000 for returns filed after August 1.
- A penalty of USD 50 for each failure, with a maximum of USD 100,000 for any calendar year, to comply with other information reporting requirements. Penalties under IRC 6723 are not subject to annual inflationary adjustments.
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