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The importance of paying taxes is one not to be taken lightly. Whether you like it or not, taxes are part of life, and living in a society means contributing is mandatory. Unfortunately, the tax system is complicated and made more so because the US government is still trying to figure out how to tax cryptocurrency.
The IRS has already issued cryptocurrency tax guidelines, but some questions remain about how you report crypto gains on your taxes.
Filing taxes incorrectly, whether crypto or otherwise, can lead to expensive tax implications. If the IRS indicates you've underpaid for the tax year, you will not only be required to pay back what you owe but also an additional penalty — usually 20 percent of the tax due. Penalties vary depending on the situation, but in any case, it's worth the time and effort to file correctly in the first place.
While IRS audits inspire fear in many taxpayers, if you do your due diligence and follow the established tax guidelines, your risk of an audit is very slim when it comes to personal finances.
As such, it's essential to keep detailed records of your crypto activity, including specific crypto holdings, the date you purchased the coin, how much you paid for it, and whether or not you sold it. In addition, you should record all information in a logbook or a spreadsheet so that if there is an audit, your digital assets records will speak for you.
In situations where the IRS believes your underpaid or negligent tax filing involved tax evasion or fraud, if convicted, you could serve a prison sentence of up to five years and a fine of up to $250,000. Jail time and excessive fines are not the norms, however. In most instances, the IRS will attempt to recover your unpaid taxes before moving forward with criminal charges.
For most people, the IRS doesn't go after you unless you're guilty of willful evasion or fraud. Failing to report cryptocurrency gains on your taxes for the first tax season you even get involved with digital currencies and crypto trading is not the same as intentionally evading taxes.
The current IRS classification says that most cryptocurrency holdings are property taxed as capital gains. You pay the capital gains tax rate on any asset that increases in value. The IRS classifies capital gains into two categories: short-term capital gains and long-term capital gains.
The IRS defines short-term capital gains as gains that accrue on assets held for less than a year from the date of purchase. Taxes for short-term capital gains are equal to your federal income tax bracket, which can range from 10 to 37 percent, which depends on your income level.
Let's look at a quick example (with everything listed in U.S. dollars): Say you bought one bitcoin in January 2019 for $3,500. Then, later that year, you sold that one bitcoin for $10,000. Since it's under a year, the IRS would tax your bitcoin as a short-term gain ($10,000-$3500, or $6,500). At this point, your income tax bracket would determine how much you pay.
Long-term capital gains accrue on assets held for more than a year from the date of purchase. The IRS uses three categories for long-term capital gains: 0 percent, 15 percent, and 20 percent, which depend on your gains and filing status (single, married, head-of-household, etc.).
Let's look at another example: Say you bought that same one bitcoin in January 2019 for $3,500. Then, after two years, you sold that one bitcoin for $60,000 in 2021. Since it's over one year, the IRS would tax your bitcoin as a long-term gain ($60,000-$3,500), or $53,000). This $53,000 gain would put you in the 10 percent long-term capital gains bracket, meaning you pay $5,300 on your profits.
While you have to report most cryptocurrency actions, there are some the IRS does not require you to report. These are:
Transferring cryptocurrencies from an exchange to another exchange or wallet in your custody.
Buying cryptocurrency (you only report when you sell).
However, the list of taxable events is relatively large. The most prominent are:
Receiving cryptocurrency as payment for goods or services.
Earning cryptocurrency through mining.
Earning cryptocurrency through airdrops of hard forks.
Cryptocurrency transactions are reported on your annual tax return like any other type of income. You'll need to report the date of the transaction, the amount of money involved, and what the transaction was for. You'll also need to declare any capital gains or losses you incurred.
If you receive cryptocurrency as payment for goods or services, you'll need to report the value of the cryptocurrency at the time of receipt. That figure is considered your gross income. You then pay tax on that amount according to your income tax bracket.
If you're mining cryptocurrency, you'll need to report any rewards you receive as income. This includes any airdrops you may have received from a hard fork. You'll also need to pay self-employment tax if your mining activity is considered a business.
Despite the growing popularity of non-fungible Tokens (NFTs), the Internal Revenue Service (IRS) has not yet published specific federal income tax guidance prescribing how they tax NFT transactions. Nevertheless, NFT transactions, like cryptocurrency transactions, are generally subject to federal (and often state) income taxation.
Investors should expect that the sale of an NFT should be treated as the sale of a capital asset, and some NFTs could meet the definition of "collectibles." The gain is subject to a higher 28% capital gain rate when collectibles are sold or exchanged. (See below for more information regarding the definition of collectibles.)
While the IRS has not given specific guidance on how they will tax NFTs, the existing guidance for virtual currencies can provide some insight. First, as discussed, the IRS considers virtual currencies property, not currency, for federal income tax purposes. Therefore, when you sell or exchange an NFT, you should recognize a capital gain or loss equal to the difference between the price paid for the NFT and its basis — the same as any other crypto gain or loss.
However, some NFTs may meet the IRS criteria for "collectibles" and, if so, would be subject to the 28% rate on long-term capital gains, a higher rate than the 0 to 20 percent most investors pay on other long-term capital gains. However, since NFT popularity is so new, it is not yet known whether any NFTs will qualify as collectibles. But since the guidance isn't clear, it's best to consult a tax advisor if you're considering buying or selling NFTs.
Another popular way to earn cryptocurrency is through staking. Staking is the process of holding onto your coins to validate transactions on a proof-of-stake blockchain. When you stake your coins, you're essentially putting them up as collateral to verify transactions. In return for your help, you earn rewards in the form of new coins.
Again, the IRS has not yet issued guidance on treating staking rewards, but they will likely be taxed as income in the same way as other forms of cryptocurrency. That means you'll need to report the value of your rewards as gross income on your tax return. You'll then pay taxes on that amount according to your income tax bracket.
Form 8938 is an IRS form used to report certain foreign assets. This includes bank accounts, stocks, and bonds in a foreign country. The IRS uses this form to ensure you're paying taxes on your worldwide income, even from outside the United States. For example, cryptocurrencies may be considered "foreign financial assets" if they're held in a digital wallet or exchange located outside the United States. Typically, the IRS requires Form 8938 only when the total value of your foreign assets exceeds $50,000.
Yes. You will have a taxable gain or loss if you sell virtual currency for cash or other property. The profit or loss is the difference between your basis in the virtual currency and the amount realized on the sale. Called the cost-basis, your basis is usually what you paid to acquire the virtual currency. The amount realized is the fair market value of the cash or other property received from the sale. You determine gain or loss by subtracting your basis from the realized amount. If the result is a negative number, you have a loss — a positive number results in a gain.
The moment you sell crypto for a real currency, like USD, you have to pay taxes on your gain. It is considered taxable income.
You report capital gains on tax form Schedule D, which the IRS defines as "The sale or exchange of a capital asset not reported on another form or schedule." So, if you traded one cryptocurrency for another or sold crypto for cash, you'll need to include those trades on Schedule D.
This is the same form used to report other investments, such as stocks or bonds. In addition, you'll need to provide the date of each trade, the amount of cryptocurrency traded, and the value of the trade in USD.
Like all other tax reporting, you'll need to report your gains or losses for one calendar year. So, for example, if you bought bitcoin on January 1st of, 2022, and then sold it on December 31st of 2022, these taxes will show up on your 2022 return, which you will file by Tax Day on April 15th of the following year.
To avoid confusion or penalties, you must keep track of all your cryptocurrency activity throughout the year. This includes every purchase, sale, trade, or exchange. Some US-based exchanges will provide you with raw CSV or excel files detailing all your activity. You may need to generate these yourself if you're using a foreign exchange.
Ember Fund makes this easy. All you have to do is tap on Transaction History in the Settings tab to download a full report of your trades, providing you with the date, amount, and value of each USD trade. This report is free and a great way to keep track of your activity without having to do any manual entries.
CoinTracking can also help you track your activity and calculate your gains or losses. This can save you time and effort, especially if you frequently trade. CoinTracking has a free version if you make fewer than 200 trades in one year and paid plans that start at around $10 a month if you make more.
As discussed, the most important thing you can do is keep track of your activity and report it accurately on your tax return. If you're not sure about something, it's better to err on the side of caution and include it. The more information you have, the easier time a qualified CPA or accountant will have preparing your return.
Remember, you're ultimately responsible for the accuracy of your tax return, even if you hire someone to prepare it for you.
Using Ember Fund to invest in crypto is more tax-efficient than trading coins on traditional crypto exchanges. This is because Ember Fund may intelligently rebalance portfolios on your behalf to help you stay diversified, but it also carefully tracks the cost basis of each asset in your portfolio. That way, when you want to sell some or all of your crypto, it can help you minimize your tax bill by selling assets with the largest unrealized gains first.
While Ember Fund cannot give direct tax advice as different jurisdictions have different rules, it provides all the necessary information for you or your accountant to calculate and report your taxes.
Download Ember Fund today and get started on your crypto journey with ease.
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