In this guide, we explore whether cryptocurrency holders and traders are liable for paying crypto tax on their digital assets. In addition, we explore when to file a tax return on cryptocurrency trades and how to calculate crypto-related taxes.
The IRS’ stance on filing crypto tax returns
The IRS has started to clamp down on digital assets such as Bitcoin (BTC), Ethereum (ETH), and Cardano (ADA) among other cryptocurrencies, which are now taxable, according to the Internal Revenue Service (IRS). The IRS is the revenue service of the United States federal government, which collects taxes and administers the Internal Revenue Code, the main body of the federal statutory tax law.
The IRS treats crypto assets as “property,” which means tax laws apply to them the same way as other assets, including stocks or gold. The dates for filing tax returns may vary, but generally, calendar year filers whose tax year ends on December 31 should file their individual income tax returns by April 15 every year.
On the other hand, tax filers using a fiscal year (any year that ends on the last day of any month other than December) should do their returns on or before the 15th day of the fourth month after the close of the fiscal year. If the due date falls on a Saturday, Sunday, or legal holiday, the date is pushed to the next business day.
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Do you owe crypto taxes?
Regular crypto users, including traders and investors, should know whether they owe crypto taxes. In the US, for example, taxpayers are required by law to report their crypto sales, conversions, payments, and income to the IRS and other state tax bodies where applicable.
Notably, each crypto transaction attracts a different tax implication, which is why it’s important to break them down so users can know when their cryptos are taxed and how their activities might affect their taxes.
The IRS considers cryptocurrency a digital asset, just like stocks, bonds, or other capital assets. Similar to these assets, cryptocurrency gains are taxed at different rates, either as income or as capital gains. Ultimately, it depends on how the user got their crypto and how long they held on to it.
Therefore, to ascertain whether one owes crypto taxes, it’s important to consider how the holder used their cryptos in a particular year. All transactions that attract a tax are known as taxable events, while those that don’t attract any tax are called non-taxable events.
Non-taxable crypto events
- When you buy crypto with cash and hold it: If you just buy and own cryptocurrency, it doesn’t attract any tax. It only becomes taxable after selling and realizing its gains;
- When you donate crypto to a charitable or non-profit organization: Just giving crypto directly to a qualified, tax-exempt organization such as GiveCrypto.org, churches and religious organizations, or private foundations, the transaction doesn’t attract taxation. More details about this are available in section 501(c) (3) of the Internal Revenue Code;
- When you receive a crypto gift: If you get crypto as a gift, you don’t incur any crypto tax until you decide to sell it or participate in a taxable activity such as staking;
- When you give crypto as a gift: The IRS limits giving crypto as a gift to an equivalent of $16,000 per recipient per year (2022). Gifts exceeding $16,000 per recipient per year require the sender to file a gift tax return. In both cases, there’s no tax obligation;
- When you transfer crypto to yourself: If you just transfer digital currencies between your accounts or digital crypto wallets, you don’t incur any crypto tax.
Taxable crypto events
The following transactions are taxable as capital gains, according to the IRS:
- When you sell crypto for cash: Selling crypto for cash, such as U.S. dollars, makes the transaction taxable, more so if you make a profit out of the transaction. If you sell the crypto at a loss, you can deduct the loss from your taxes;
- Crypto conversions or swaps: If you use one cryptocurrency to buy another crypto asset, it accounts for selling one digital currency to buy another asset. The IRS considers it a sale, and therefore, it’s taxable. For instance, if you sell Bitcoin more than you bought it, you owe crypto taxes.
- When you buy goods and services with crypto: Using Bitcoin to buy coffee, for instance, attracts taxes on the transaction. The IRS regards the transaction as selling the crypto asset first before it can be used to pay for a commodity or service, and this makes it subject to capital gains taxes.
Crypto events taxable as income
The following crypto events are taxable as income:
- When you’re paid in crypto: If you get a paycheck in Bitcoin or any other cryptocurrency from an employer, you owe income tax on the amount transacted;
- When you accept crypto as payment: If you get paid in crypto in exchange for goods or services delivered, the IRS considers it an income, and so it’s taxable.
- Crypto mining: If you mine Bitcoin or other cryptocurrencies, you owe taxes on your earnings based on the prevailing market value at the time you received the coins. If you mine crypto as a business, it’s taxed as self-employment income.
- Staking rewards: The IRS treats staking rewards as mining proceeds, making them taxable according to the fair market value of the rewards at the time of receipt.
- Hard fork earnings: Cryptocurrency derived from a hard fork is taxable based on how the asset is used and when it’s ready to withdraw from a crypto exchange, among others. The IRS gives more details about taxes on hard fork earnings here.
- Airdrop earnings: If you receive an airdrop from a crypto company as a giveaway or part of a marketing campaign, it’s treated as taxable income.
Are NFTs taxable?
Non-fungible tokens (NFTs) are relatively newer assets in the crypto space, but that doesn’t mean they’re not covered under the tax code. Therefore, the IRS is paying attention to these digital assets as well.
NFTs are collectible digital assets that cannot be copied or replaced with anything else. The creator remains the sole owner of the item, which can be bought or sold in digital marketplaces. They are created in limited quantities to maintain scarcity. Most NFTs run on the Ethereum blockchain even though other blockchains have also created their versions of NFTs.
So far, there’s no NFT-specific tax guidance from the IRS. However, NFTs are more likely treated as “collectibles” under section 408(m)(2) of the tax code. So like crypto, NFTs are taxable. Taxation of these digital assets is based on how the user interacts with them, and there are two ways to do it:
- As a creator: Creating and selling NFTs in digital NFT marketplaces.
- As an investor: Buying and selling NFTs.
NFT creators owe ordinary income and self-employment taxes. This happens when they sell NFTs. For example, if a creator sells a piece of NFT art for two ether (ETH) coins valued at $3,000, the creator is required to report $3,000 as ordinary income. The income also attracts self-employment taxes. Creators who are in the business or trade of creating NFTs can subtract ordinary and necessary business expenses to equalize the income.
On the other hand, NFT investors are those involved in buying and selling digital collectibles for speculative purposes. NFT investors owe taxes similar to those levied on cryptocurrency trading. Non-fungible tokens are bought or sold using cryptocurrencies, so the transactions attract a tax because the IRS considers it an act of selling cryptocurrency, which is treated as property.
Knowing how much you owe in crypto taxes
Now that you have an idea of what is taxable, it’s time to estimate how much you owe in crypto taxes. You can do this by calculating your income, profits, and losses using a crypto tax calculator.
How to calculate your crypto income
Taxpayers, for example, in the U.S., are used to seeing their federal and state income tax subtracted from their pay stubs. Any crypto received as income, including mining, staking, or rewards, is subject to income taxes too. Generally, each taxpayer owes according to the income tax rate for their tax bracket.
How to calculate capital gains and losses
The profit one makes after selling a digital asset is equal to the capital gain on the sale. According to the IRS, all capital gains derived from crypto sales are taxable, and the crypto tax rate depends on how long the asset is held before selling it.
To calculate the amount gained or lost, taxpayers need to know how much crypto they started with. That amount is called their cost basis. For example, when buying cryptocurrency, the cost basis generally depends on how much the buyer pays. However, if crypto is received from mining or staking, the cost basis depends on the fair market value at the time of reception.
For gifted cryptos, the cost basis depends on the giver’s cost basis and the fair market value at the time of reception. To arrive at a capital gain or capital loss, the cost basis is deducted from the sale price. If the proceeds exceed the cost basis, it’s a capital gain. On the other hand, if the proceeds are less than the cost basis, it’s a capital loss.
Short-term vs. long-term capital gains
Capital gains can be either short-term or long-term, and each of them attracts different tax rates. Short-term capital gains are derived from selling assets held for one year or less. They are treated like regular income, and so the taxpayer just pays the same tax rates paid on federal income tax.
On the other hand, long-term capital gains are derived from assets held for more than one year. They attract lower tax rates compared to short-term capital gains. Importantly, the rates vary according to the taxpayer’s income.
Understanding capital losses
According to the IRS, events are only taxable when one realizes gains or losses through selling crypto for cash, converting it to another crypto, or spending it on a commodity or service. No gains or losses are realized if the holder still owns the original shares.
IRS tax forms explained
The IRS requires crypto exchanges, brokers, and taxpayers to report some types of activity directly to the agency. This is done using specific tax forms, such as the following:
- Form 1099-MISC: This form is used for reporting capital gains of at least $600 derived from crypto staking or rewards through brokers or crypto exchanges;
- Form 1040: This form is used to determine a taxpayer’s total taxable income. It’s also known as the U.S. Individual Income Tax Return.
- Form 8949: This form is a worksheet that shows a taxpayer’s capital gains or losses derived from selling crypto, conversions, or other ways of disposing of crypto.
- Schedule 1: Also known as Additional Income and Adjustments to Income, taxpayers use this form to report any other income from their 1099-MISC, including mining, staking, or NFT sales.
- Form 1040 Schedule D: Usually known as “Schedule D,” this form is used by taxpayers to summarize their capital gains and losses.
Tracking your crypto tax activity
Every crypto holder or dealer is responsible for keeping track of all their potentially taxable activities, including the fair market value of their crypto, throughout those events. The IRS often gives only general guidelines about the records taxpayers need to keep for tax reporting purposes.
However, the IRS guidelines only serve to establish its position on tax returns. Sometimes the agency may give records of each time a person receives, sells, or exchanges digital currency, including the fair market value of the crypto asset. Overall, taxpayers should actually track their cost basis and ensure they do it right.
Some crypto exchanges provide their customers with a Form 1099-B to record their gains and losses, but it’s rare. Perhaps things might change for the 2023 tax year, following the signing into law of the bipartisan infrastructure bill by President Biden in November 2021.
According to the new law, crypto exchanges will be required to issue the IRS directly with a Form 1099-B detailing all crypto transactions of their customers, with the bill operating officially in 2023. Until then, taxpayers will need to be more vigilant in tracking their crypto activities.
For example, taxpayers can use crypto-focused tax software programs such as CoinTracker, CryptoTrader.Tax, TokenTax, and more to help simplify the process. These programs help generate the cost basis for the users’ trades and determine their capital gains and losses, as long as they key in data on all their crypto trades or earnings and their sources.
Preparing for a tax season
To avoid a last-minute rush with tax filing and related responsibilities, taxpayers should plan ahead, gather their reports early enough, and figure out what they owe.
For instance, treating their crypto deals as a business where on a monthly basis, they ensure all their taxes are up to date can help taxpayers realign everything early enough to simplify the tax filing process.
For some taxpayers, the tax filing process can be simple once they have a Form W-2 and a couple of 1099 interest forms, and some crypto. Such people don’t necessarily need the services of a certified public accountant (CPA) or a tax expert.
However, taxpayers handling large amounts of money, making Decentralized Finance (DeFi) transactions, or engaging in staking or mining operations require a CPA to do proper tax planning, interpret tax code related to cryptocurrencies, and infuse tax-saving strategies.
While the crypto space is a relatively new field to explore, the IRS has stepped up enforcement and surveillance on potential tax evasion by persons involved in crypto deals, including mining, trading, staking, and more.
Knowing how to track their cost basis, noting their effective gains and losses, as well as knowing the right tax forms to use can help taxpayers complete a proper tax filing process.
Additionally, preparing for a tax season, engaging the services of a professional, and submitting their tax reports on time can help taxpayers avoid unnecessary tax evasion.
FAQs on paying taxes on crypto
Is cryptocurrency taxable?
Yes, cryptocurrencies and other digital assets are taxable. The IRS categorizes crypto as “property,” just like stocks, bonds, gold, and other assets.
How do I know if I owe crypto taxes?
If you trade or mine cryptocurrency, if you receive crypto in exchange for goods or services, if you make any purchase with crypto, you’re most likely going to pay tax on these events.
What are capital gains and capital losses?
Capital gains are the profit derived from the sale of crypto and other digital assets such as NFTs. Capital gains occur when the selling price of an asset exceeds its cost basis. A capital loss is the opposite of capital gain. It results in a loss when the selling price is lower than the cost basis.
What happens when I don’t disclose my crypto activity for a tax year?
Failure to disclose your crypto activity for a tax year is a punishable offense under the Internal Revenue Code. First-time offenders receive a notification from the IRS that they haven’t filed their annual returns or reports. Taxpayers who fail to declare their crypto gains and losses after 90 days from the date of notification could face a fine of up to $50,000.
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.