Over 13% of Americans started investing in cryptocurrency last year, compared to 24% who invest in traditional stock options. The growing popularity of cryptocurrency is starting to attract much attention, especially from the IRS. Prior to this, cryptocurrency sort of lived in this grey area when it came to reporting.
As it’s become more mainstream, new tax laws are leaving many in unintentional non-compliance and this could result in penalties. The reason for this is usually is nothing more than a confusion of what to report. It also doesn’t help that these laws are constantly changing as they figure out how best to account for this growing stream of revenue. With all of these changes, there’s a much greater likelihood to either overreport or underreport cryptocurrency gains and/or losses.
The IRS recently added a question on Form 1040, asking about the sale, trade, exchange, or receipt of financial interest on cryptocurrency. Essentially, this means if you’ve transacted with cryptocurrency, you must report it on your cryptocurrency tax forms. If you answer yes to this question, you will also need to file an 8949 tax form, used for reporting gains and losses from stocks and equity, as well as cryptocurrency gains and losses. These additional forms can make
cryptocurrency reporting tricky, especially since some transactions can trigger capital gains while others count as ordinary income.
Cryptocurrencies as capital assets:
Cryptocurrencies are capital assets, which means that they receive similar tax treatment to stocks. Any realized income from appreciation in the value of the crypto asset is taxable as a capital gain, while in some cases you can offset it against a capital loss.
Example of common crypto transactions that trigger capital gains (required on 8949 tax form): :
- Sale of cryptocurrency for cash
- Exchange of one virtual currency for another
- Using cryptocurrency or crypto debit cards to pay a merchant
In addition to gains and losses, you will also need to report:
- Mining or staking cryptocurrency
- Receipt of airdropped tokens because of a hard fork
- Payments received in the form of cryptocurrency
Non-taxable crypto transactions (not required to report on the 8949 tax form):
- Buying cryptocurrency and holding
- Transferring cryptocurrencies between exchanges or wallets
- Gifting cryptocurrency, not including large gifts that could result in other tax liabilities
- Donating cryptocurrency, which in fact, is tax-deductible
Long Term vs. Short Term Capital Gains:
A long-term capital gain is when the cryptocurrency asset is sold after having it over a year. When this happens, the long-term capital gains rate applies, which ranges from 0% to 20% depending on your income tax rate. A short-term capital gain occurs when you sell the cryptocurrency asset after having it for less than one year. In this case, the capital gains from your crypto transactions are then added to your income and taxed at your ordinary income tax rate.
When it comes to mining digital currency there are numerous tax implications that a user will need to understand and then report on using multiple forms. Differences on what information you will need to include depends on whether you treat your cryptocurrency transactions as a business or as a personal investment.
When mining crypto as a ‘Business’ you must include:
- File as a sole proprietorship, corporation, or limited liability company (LLC)
- Report and deduct ordinary and necessary expenses incurred as part of the business
- If filing as a sole proprietorship, you will pay an additional 15.3% self-employment tax and will report income and expenses on Schedule C of Form 1040
- Tax considerations when mining crypto as a personal investment
When mining crypto as a ‘Personal Investment’ you must include:
- Report their income on Line 8 of Form 1040 (other income)
- Pay taxes on their entire crypto income at their ordinary income rate
- Investors who mine crypto in their free time will usually be better off treating the activities as a personal investment. It’s difficult to incur enough deductible expenses to make taking on the extra self-employment taxes worthwhile.
There are many subtle nuances regarding cryptocurrency tax laws that can be very confusing. Not to mention all of the additional paperwork and forms that you may need. If you have a question on cryptocurrency tax laws, feel free to reach out to Herman & Company – Accounting & Consulting for more information.