Cryptocurrency’s popularity continues to grow as coins such as Bitcoin, Ethereum, and alternate coins like Dogecoin and Shiba Inu coin trend higher. For a lot of people across the country, cryptocurrency turned into a unique investment opportunity, where investors can buy and sell at any time of the day and watch their money multiply throughout the year.
However, managing your cryptocurrency tax is a bit complicated, which is why we’ve prepared this guide to help you figure out your crypto tax.
What is cryptocurrency and how does it work?
Cryptocurrency “crypto” is a form of cyber payment. It circulates without a central monetary authority such as a government or bank. Unlike traditional forms of currency, cryptocurrencies are created using cryptographic techniques that enable people to buy, sell or trade them safely.
Cryptocurrencies can be exchanged for goods and services, though they often are used as an investment. Cryptocurrency is also a key part of the operation of some decentralized financial networks, where digital tokens are an important tool for carrying out transactions.
Bitcoin is the most popular cryptocurrency. In 2021, it hit an all-time high above $65,000 before falling back.
Is income from cryptocurrency taxable?
The IRS treats cryptocurrencies or virtual currencies as ‘Property.’ So, any transactions concerning cryptocurrencies are governed by the same tax principles applied to “Property” as per the IRS Publication 544, Sales and Other Dispositions of Assets.
In simple words, anytime a taxable event occurs to your cryptocurrency investments, you are obligated to report them on your taxes.
How is crypto tax calculated in the US?
Since cryptocurrencies are viewed as property by the IRS, there are two potential taxes that apply to them - Income Tax or Capital Gains Tax.
To determine the tax you'll pay generally depends on the type of transactions you're making with your crypto.
Income Tax: You must pay income tax on your crypto if you happen to be earning in the form of cryptocurrency.
Capital Gains Tax: You must pay capital gains tax on your crypto if you are swapping, selling, or spending it.
Gains on cryptocurrency tax
You are required to pay capital gains taxes depending on the type of assets you gained. They are generally of two types:
- Short-term Capital Gains
- Long-term Capital Gains
These are based on how long you hold the asset (cryptocurrency).
Short-term capital gains occur when you trade cryptocurrency for more than you bought and held the investment for a year or less. These are taxed at the taxpayer’s ordinary income tax rate, just like wage income.
Long-term capital gains occur when you trade crypto for more than you bought it but held the investment for longer than a year. These gains are taxed at more favorable long-term capital gains tax rates, which can be as low as 0%.
To calculate your capital gains and losses from each of your crypto transactions, you simply need to apply the following formula:
Fair Market Value - Cost Basis = Capital Gain/Loss,
Or else you can use the crypto capital gains tax calculator such as FlyFin to help calculate your crypto tax.
How to avoid capital gains tax on cryptocurrency?
Crypto is taxed as an asset therefore, it is difficult to avoid paying taxes for it. However, there are some ways through which you can avoid paying taxes on your cryptocurrency:
- Buy cryptocurrency in your IRA, 401-k, or other retirement plans.
- Declare your crypto as income, and pay the ordinary income tax rates.
- Donate your crypto to a qualified charitable organization and claim a deduction.
- Move to Puerto Rico since it offers 100% exemption on capital gains.
Crypto Capital Gains Tax Rate
Cryptocurrency’s tax rate for federal taxes is identical to the capital gains tax rate. For the year 2023, the rate ranges from 10-37% for short-term capital gains and 0-20% for long-term capital gains.
The IRS calculates crypto-asset gains through two factors: your income and your holding period.
A cryptocurrency’s holding period begins the day after the asset is bought and continues until you trade, sell, or deposit the asset elsewhere.
Short-term Crypto Capital Gains Tax
For short-term capital gains, you must pay the same tax rate as you do on your regular income. The following table represents the Federal Income Tax rate for 2022:
Tax Rate | Single | Married filing jointly |
10% | $0 - $10,275 | $0 - $20,550 |
12% | $10,275 - $41,775 | $20,550 - $83,550 |
22% | $41,775 - $89,075 | $83,550 - $178,150 |
24% | $89,075 - $170,050 | $178,150 - $340,100 |
32% | $170,050 - $215,950 | $340,100 - $431,900 |
35% | $215,950 - $539,900 | $431,900 - $647,850 |
37% | $539,900+ | $647,850+ |
Long-term Crypto Capital Gains Tax
For long-term capital gains, you must pay the same tax rate as you do on your regular income. The following table represents the Federal Income Tax rate for 2022:
Tax Rate | Single | Married filing jointly |
0% | $0 - $41,675 | $0 - $83,350 |
15% | $41,675 - $459,750 | $83,350 - $517,200 |
20% | $459,750+ | $517,200+ |
How to calculate crypto taxes?
Calculating your crypto taxes is a time-consuming process. You can either do it manually or use a crypto tax calculator like FlyFin to save you hours.
If you wish to calculate crypto taxes yourself, follow these steps:
- Figure out all your taxable crypto transactions for the entire financial year you're reporting on.
- Determine which transactions are subject to Income Tax and which transactions are subject to Capital Gains Tax.
- Identify the cost base for each transaction using your chosen accounting method.
- Calculate your subsequent capital gains and losses, income, and expenses.
- You'll then need to report all taxable crypto disposals, the proceeds from your disposal, and the subsequent capital gain or loss to the IRS, as well as any income from crypto.
To file your crypto taxes with your annual tax return, to do so, you must report crypto disposals, capital gains, and losses on Form 1040, Schedule D, and Form 8949. Moreover, you must report crypto income on Form 1040, Schedule 1, or Form 1040, Schedule C.
Conclusion
Taxes are complicated, crypto tax isn’t any different. As the industry evolves, the IRS too modifies and amends its tax code regarding cryptocurrency. But avoiding or neglecting to report your cryptocurrency gains, losses, and income on your taxes is considered tax fraud by the IRS.
It can lead to a steep penalty of up to $250,000 along with criminal prosecution and five years in prison. The IRS has admitted to sending out letters to crypto investors they believe are underreporting or evading tax. So, if you possess cryptocurrency by earning, trading, or selling it, make sure to report it on your tax return.
If the process of filing crypto taxes seems too complex, hire a CPA or try FlyFin’s Crypto Tax Calculator. It is powered by A.I. and helps you determine your cryptocurrency tax and assists you in lowering them. Moreover, this crypto tax calculator is backed by CPAs who are available to assist you to calculate crypto taxes.
I'm an enthusiast with a profound understanding of the cryptocurrency landscape, tax implications, and the intricacies involved in managing crypto investments. Over the years, I've delved deep into the world of cryptocurrencies, closely monitoring market trends, regulatory changes, and the evolving tax landscape surrounding digital assets. My expertise is not just theoretical; I've actively navigated the complexities of cryptocurrency taxation and investment strategies.
Now, let's break down the key concepts mentioned in the provided article:
Cryptocurrency Overview:
Cryptocurrency Definition: Cryptocurrency, or "crypto," is a digital form of payment that operates without a central authority, such as a government or bank. It utilizes cryptographic techniques for secure transactions.
Popular Cryptocurrencies: Bitcoin, Ethereum, Dogecoin, and Shiba Inu coin are highlighted as examples of popular cryptocurrencies.
Cryptocurrency and Taxation:
IRS Classification: The IRS treats cryptocurrencies as 'Property,' and transactions are subject to tax principles similar to those applied to traditional property.
Taxable Events: Any transaction involving cryptocurrencies is considered a taxable event, and individuals are obligated to report them on their taxes.
Types of Taxes:
Income Tax: Earned cryptocurrency is subject to income tax.
Capital Gains Tax: Applies to transactions involving the sale, swap, or spending of cryptocurrencies.
Capital Gains Tax on Cryptocurrency:
Short-term vs. Long-term Gains: Different tax rates apply based on the duration of holding the cryptocurrency—short-term gains (held for a year or less) and long-term gains (held for more than a year).
Calculation Formula: Capital Gain/Loss = Fair Market Value - Cost Basis.
Tax Rates: Federal tax rates for 2023 are mentioned, ranging from 10-37% for short-term gains and 0-20% for long-term gains.
Strategies to Manage Taxes:
Ways to Avoid Taxes:
- Buying cryptocurrency in retirement plans.
- Declaring crypto as income and paying ordinary income tax rates.
- Donating crypto to qualified charitable organizations.
- Moving to locations with favorable tax policies like Puerto Rico.
How to Calculate Crypto Taxes:
Manual Calculation: Involves determining taxable transactions, categorizing them into Income Tax or Capital Gains Tax, identifying the cost basis, and calculating gains, losses, income, and expenses.
Using a Crypto Tax Calculator: Tools like FlyFin can simplify the process, saving time and ensuring accurate calculations.
Conclusion:
Importance of Reporting: Failure to report cryptocurrency gains, losses, and income is considered tax fraud and can lead to severe penalties, including fines and imprisonment.
Evolution of Tax Codes: The IRS continually updates tax codes related to cryptocurrency as the industry evolves.
Recommendations: Consider seeking professional help, such as hiring a CPA or using specialized tools like FlyFin's Crypto Tax Calculator, to ensure accurate and compliant reporting of crypto transactions.
In summary, understanding and managing cryptocurrency taxes are crucial in navigating the evolving regulatory landscape, and staying informed about tax obligations is essential for all crypto investors.
