Cryptocurrencies have been extremely popular all over the world, including in the USA, for several years. For many investors, they have become a great opportunity to increase their wealth. Cryptocurrencies have gained popularity mainly due to blockchain technology, anonymity and the potential for increasing value.
In this article, we will focus on cryptocurrency tax issues in the United States.
Do you have to pay cryptocurrency tax?
Cryptocurrencies are often called virtual currencies, but in the eyes of the Internal Revenue Service (IRS) they are not considered real currency. Importantly, under IRS Notice 2014-21, capital gains and losses must be reported on a Schedule D tax form and Form 8949.
Even though cryptocurrencies are decentralized in nature, the IRS treats them as property. Therefore, profits and losses related to cryptocurrency transactions mostly affect your taxes.
If you buy, exchange or sell cryptocurrencies in a non-registered (non-retirement) account, you are subject to tax on capital gains or losses.
When it comes to settling cryptocurrencies, you must remember that, like other investments taxed by the tax office, profits or losses can be both short-term and long-term.
If you owned your cryptocurrencies for a year or less before you disposed of or sold them, the gains from that transaction are usually taxable as short-term capital gains – they are taxed at your ordinary income rate.
If you have held your cryptocurrency for more than a year, the gains are generally taxable as long-term capital gains – they are taxed at your long-term capital gains tax rate.
How much is the taxation on cryptocurrencies?
For short-term capital gains and income related to digital currencies, the tax rate ranges from 0% to 37%. However, taxation on long-term capital gains ranges from 0% to 20%.
Even though NFTs are considered collectible assets, you have to pay tax on them. In the USA it is 28%. It is worth noting that the tax rate on cryptocurrencies in this country depends on your earnings, specific transactions and how long you held specific assets.
In the United States, in some cases, you do not have to pay tax on cryptocurrencies. We are talking about situations such as:
- holding cryptocurrencies
- transferring cryptocurrencies between your wallets
- buying cryptocurrencies with fiat currency
- gifting cryptocurrencies – the condition here is not to exceed the lifetime gift
- donating virtual currencies to charity – limit of $5,000 (if this rate is exceeded, an appropriate valuation is required)
- creating NFTs
Can the US Internal Revenue Service track cryptocurrencies?
Yes, the US Internal Revenue Service (IRS) is authorized to track cryptocurrency flows. Currently, all largest cryptocurrency exchanges are obliged to carry out the KYC (Know Your Customer) procedure. Of course, we are talking about verifying the identity of customers.
When exchanging fiat currency for cryptocurrency, crypto exchanges process banking information. Many of them keep records of the cryptocurrency addresses to which you have withdrawn your funds. This procedure means that they can also identify your trust portfolios.
Information related to the turnover of your virtual currencies is provided by crypto exchanges to the IRS. They are reported on Forms 1099.
In the past, the largest cryptocurrency exchanges, e.g. Coinbase or Kraken, did not provide their customers’ data to the tax office. Because of this, the IRS filed lawsuits against them and won. Since then, the largest cryptocurrency exchanges in the world have been forced to share customer data with the tax office.
What does tax settlement look like in the USA?
What does tax settlement look like in the USA?
When submitting your tax return, you must state whether you have made any transactions related to cryptocurrencies. More specifically, Form 1040 asks whether you received, sent, exchanged, sold or otherwise disposed of virtual currency during the tax year.
In your tax return, you must clearly answer whether you used cryptocurrencies. Of course you can’t lie to the tax office. If your tax return is not accurate, you will be at risk of further legal problems – the IRS severely punishes those who file false tax returns.
In practice, however, most cryptocurrency holders in the US do not report information related to them to the IRS. This data was published by DIvly, which conducted an in-depth analysis. This company helps settle taxes related to cryptocurrencies.
Tax return for cryptocurrency holders
According to research, only about 1.6 percent of cryptocurrency owners in the U.S. reported their ownership on their tax returns last year.
However, it is worth knowing that there is an exception, thanks to which if you have cryptocurrencies on Form 1040, you do not have to answer “yes” to this question. Only people who have only purchased virtual currencies for real money have the right to do so.
Usually, you receive a 1099 form from your bank or broker, but also from the IRS. It concerns how much income you maintained during the tax year. However, it should be remembered that in the case of cryptocurrencies this may not be the rule.
The important news is that in 2021, an act was introduced in the United States aimed at forcing more accurate tax reporting for people who dispose of their cryptocurrencies. The act entered into force at the beginning of 2023. It obliged brokerage firms to report information related to cryptocurrency trading to the IRS on Form 1099 or a similar form.
Even if you don’t get a Form 1099, you’re not exempt from paying tax on your cryptocurrency income. However, if you have a capital loss, you can deduct it from your tax return. This way you can reduce your taxable income.
Cryptocurrency exchange for real money
Each time you want to exchange virtual currency for real money, goods or services, you will be required to submit a tax return.
You must file a cryptocurrency tax return when the price you received for your cryptocurrencies exceeds the cost of purchasing them. This refers to a situation where you received more value (goods or real money) than you spent on purchasing virtual currencies. In this case you have to pay tax.
In the above-mentioned case, however, we are not talking about tax on the transactions themselves. This is a capital gains levy, i.e. taxation of the actual change in the value of cryptocurrencies.
It’s the same with stocks you buy and hold – unless you exchange cryptocurrencies for something else, there’s no tax gain or loss.
Forgot to report your cryptocurrency tax?
Most cryptocurrency investors do not realize that income related to their trading must be reported in their tax return. If you forgot to do this, you don’t have to worry.
What to do if you forgot to report your cryptocurrency tax?
There is an option to amend your tax return for an earlier year. This includes income related to cryptocurrency trading. You can amend your tax return using IRS Form 1040X.
In any case, it will be better to submit a correction of the return in good faith than to wait until the IRS itself detects the irregularities. Of course, there is no guarantee that you will not be subject to a tax audit after submitting the amendment. However, it is worth remembering that paying your late tax before the IRS begins an investigation will help a lot. Thanks to this action, the US tax office will know that the probability of further errors in your returns will be low.
Capital gains and losses – how to calculate them?
To calculate capital gains and losses related to trading in virtual currencies, you only need to use one formula: revenue – basic cost = capital gain or loss.
For this purpose, you need to know what revenue is. Well, this is the value you received in exchange for selling your cryptocurrency. Typically, this is the market value of your assets at the time you sell them, less the costs associated with the transaction.
The base cost is the amount you spent to buy cryptocurrency. It includes the purchase price or all other costs related to the acquisition of your asset, e.g. fees and the like.
It is worth explaining the above formula with an example. In case you buy 1 Dogecoin for USD 300, your base cost is USD 300 per 1 Dogecoin. If you trade or sell it when it is worth $500, your income is $500.
Using the formula mentioned above (revenue – basic cost = capital gain or loss), $500 (revenue) minus $300 (basic cost) = $150, or profit.
Buying cryptocurrencies and tax
When you buy cryptocurrencies, you are not subject to tax. You can buy them and keep them in your wallet and do not pay tax on them, even when their value increases.
You only have to pay tax on cryptocurrencies when you sell them, exchange them or use them for investments in a way that results in the recognition of profit in your tax return. The exception to this rule is when you trade cryptocurrencies in a tax-deferred or tax-exempt account. It’s worth replacing your retirement account in this case.
Therefore, for example, if you buy Bitcoin for $2,000 and later sell it for $2,300, you must report a gain of $300 on your tax return.
Capital gain can be both short-term and long-term, depending on how long you held the cryptocurrency.
However, if you sold the same Bitcoins for $1,800, you are dealing with a loss that can offset other gains of up to $3,000 in taxable income.
However, the condition is that the losses exceed the total profits. Importantly, any unused loss can be carried forward to future years as compensation for future profits.
When can cryptocurrency be treated as income instead of capital gain?
Cryptocurrency can be treated as income instead of capital gain in several cases. One of them is to receive remuneration in cryptocurrency. This also includes:
- hobby cryptocurrency mining
- receiving aidrops, i.e. free tokens
- receiving rewards for staking, i.e. holding cryptocurrencies
- receiving new coins as a result of the so-called hard fork
- receiving bonuses for referrals
With the development of decentralized finance, or DeFi for short, there are many alternative ways to earn cryptocurrencies. The US Internal Revenue Service has not yet issued specific guidance on many of these transactions, but this may change in the future. Moreover, this does not mean that they are not subject to taxation.
A common example of a new way to monetize cryptocurrencies in DeFi is to earn interest on lending protocols. It is worth mentioning Compound here. It is also worth mentioning receiving new tokens from liquidation pools or rewards from protocols, e.g. Uniswap.
Another example of a new way of making money from cryptocurrencies is receiving rewards for staking tokens. In addition, more and more platforms allow their users to earn digital currencies through various activities.
Many of the above-mentioned transactions do not yet have clear IRS guidance regarding taxation, especially these newer DeFi protocols.
However, you must remember that earning cryptocurrencies through staking or mining is considered income, so there is a high probability that earning through these or other platforms will also be treated as income from a tax perspective.
In the above-mentioned cases, it is best to consult a tax advisor specializing in cryptocurrencies.
Cryptocurrency settlement and mining
Cryptocurrency mining refers to solving cryptographic hash functions. The purpose of this action is to verify and add cryptocurrency transactions to the blockchain. In exchange for mining cryptocurrency, the miner receives a reward in the form of a digital asset.
When you earn cryptocurrency by mining it, the IRS considers it taxable income and can be reported on Form 1099-NEC as the fair market value of the digital currency on the date you received it.
In the above-mentioned situation, you are obliged to file a tax return for income from cryptocurrency mining. You must report the profit even if you do not receive a 1099 form. The US Internal Revenue Service considers profit from cryptocurrency mining as taxable income. It applies to both business activity and income tax.
Cryptocurrency as payment for goods or services
It is becoming increasingly common for companies around the world to accept Bitcoin or other digital currencies as a form of payment. When someone pays you in cryptocurrencies for a good or service, the payment is considered taxable income. The same applies to paying with cash, check or credit card.
If the goal is to settle taxes, the USD value you receive for services or goods is equal to the market value of Bitcoin or other cryptocurrency on the day you receive the payment.
Just like investing in stocks, settling taxes related to cryptocurrencies can be complicated. All transactions of sale, purchase or issuance of cryptocurrencies are treated as capital transactions in the USA. In short, this means that they may result in a profit or loss, which must be included in the annual tax return.
Exchanging one cryptocurrency for another
Cryptocurrency investors often exchange their cryptocurrency for another one. What does the issue of taxation look like in such a case? It will be best to illustrate this with an example.
Let’s say you have $1,500 worth of Bitcoin and you exchange it for $1,500 worth of ETH. If you initially paid $500 for your BTC, you must recognize a capital gain of $1,000 when you exchanged it.
Your new base costs for ETH are the market value of that cryptocurrency at the time of exchange, or $1,500. This means that if you sell this digital currency in the future for an amount greater than USD 1,500, you will be charged capital tax on the difference between the sale amount and the basic cost.
It is worth adding that all transactions mentioned above are reported in US dollars. This currency is used in tax settlements in the USA. Even when you buy one cryptocurrency using another without exchanging it for USD, you still need to take into account the value of the transaction and report the potential gain or loss on your tax return.
Airdrop and hard fork
If we are talking about tax issues related to cryptocurrencies, it is also worth explaining Aidrop, i.e. a situation when a new virtual currency project is just being launched and the initial participants and their community receive an incentive to adopt this project in the form of free tokens. This is a marketing activity aimed at promoting the creation of a new cryptocurrency.
If you are a user of cryptocurrency platforms and exchanges, you can receive aidrop of new tokens to your account. This option is usually intended for active people.
Aidrops of new tokens are considered taxable events. This means that you also have to pay tax on them.
The issue of taxation of cryptocurrencies in the event of a hard fork can be quite complicated. It is worth explaining at the beginning what we are dealing with here. A hard fork is a significant change to the blockchain network protocol in that it may invalidate previously verified blocks of transaction history or vice versa.
Often, creators of cryptocurrency projects decide to conduct a hard fork in order to implement new rules into their blockchain. The new version contains new improvements, while the old one does not.
Many users of the old blockchain quickly realize that their old version is outdated or out of date after the hard fork, forcing them to update to the latest version of the blockchain protocol software.
Hard Fork – taxation
For a hard fork to work flawlessly, all blockchain nodes and users must update to the latest version of the protocol software. You should also know that this process does not always result in the issuance of a new cryptocurrency and does not always generate taxable events.
However, if the hard fork is preceded by an aidrop in which you receive a new virtual currency, it generates regular revenue. It is treated as taxable income on your tax return and you must report it to the IRS whether you receive a Form 1099 reporting the transaction or not.
The US Internal Revenue Service expects you to report all your income, including cryptocurrency-related income, even if you don’t receive a form reporting this transaction.
Cryptocurrency taxation in the case of a hard fork depends on whether it is connected to an aidrop that generates new revenue.
How to avoid paying taxes on cryptocurrencies?
According to CNBC (Consumer News and Business Channel), as many as 20% of Americans have invested, traded or used cryptocurrencies. Research confirms that the digital currency market is growing, but at the same time it also poses a challenge for legislators trying to introduce well-functioning tax regulations.
Therefore, many people are looking for ways to avoid paying taxes on their cryptocurrency investments. Currently, there are some proven strategies that can be helpful to minimize your tax liability on digital currencies. Such methods include:
- Individual Retirement Account (IRA)
- Long investment horizon
- Gifting cryptocurrencies
- Moving to another country
- Buying items
- Donating cryptocurrencies to charity
- Balancing the gains.
Individual Retirement Account (IRA)
Individual Pension Account is a special savings account that was created to help people who are saving for retirement. There are several types of IRAs today, but two are particularly helpful for avoiding cryptocurrency taxes – the Roth IRA and the traditional IRA.
In the case of the latter, payments to the account are tax deductible. In short, this means you don’t have to pay capital gains tax until you withdraw the funds in retirement. This is very beneficial because you can minimize your tax burden over the life of the account.
A Roth IRA, on the other hand, works in a slightly different way, in that contributions are made from already taxed income, but withdrawals are tax-free. Thanks to this, when you invest in cryptocurrencies using this account, their value will increase and you will not pay capital gains tax when you withdraw the funds in retirement.
Importantly, all capital gains in a Roth IRA are tax-free, but under strict conditions. This is a situation where an investor bought Bitcoins using a Roth IRA and the coin doubled its value – then he does not have to pay tax on the profit.
How to avoid cryptocurrency tax with an IRA account? It turns out that the most popular approach is by far working with an IRA provider that allows you to invest in digital assets.
Interestingly, the above-mentioned accounts are often called “cryptocurrency IRAs”, even though some providers also offer this type of accounts with stand-alone investments that enable purchases of virtual currencies.
An IRA account holder can have access to the most popular cryptocurrencies. They can be purchased via the supplier’s platform, which is its undoubted advantage. Thanks to this, the investor has a simplified process and can pay lower taxes.
Long investment horizon
If your goal is to avoid paying cryptocurrency tax, you may want to consider other options. One of them is the strategy of holding your digital assets for the long term. In this regard, there are two ways that will help you do this.
The first approach is when you do not sell your cryptocurrencies, you do not generate capital gains and, therefore, you do not pay tax on the profits. It is obvious that this option is not the right choice for everyone, as you cannot use your cryptocurrencies for consumption purposes.
There is also a second approach. This involves holding cryptocurrencies for a long enough time to qualify for a lower long-term capital gains tax rate. According to experts on the taxation of virtual currencies, digital assets held for a minimum of one year qualify for a lower capital gains tax rate. Thanks to this, the investor can significantly reduce his tax burden.
You should also be aware that taxpayers with a low income may be completely exempt from capital gains tax. In the United States, single people earning income below a certain threshold will not pay any capital gains tax at all. However, taxpayers earning income in a higher bracket pay a lower rate in this respect.
Gifting (donation) of cryptocurrencies
Another way to avoid taxation is to gift cryptocurrencies to another person. This is a relatively simple solution that can be applied in the USA. Typically, the act of gifting is not considered a taxable event. This means that both the investor making the gift and the recipient do not have to pay tax on the amount donated.
Before using this approach, it is worth knowing the most important rules. For example, under current U.S. law, a cryptocurrency investor can only gift $17,000 per person in a year before having to file a gift tax return.
You should also remember that the person receiving cryptocurrencies as a gift will have to pay tax on the capital gains that he or she makes after receiving them in his or her account.
However, there is a very interesting option for US citizens. It turns out they have the ability to exclude $12.92 million in gift and estate tax over their lifetime. For married couples, this amount is USD 25.84 million. However, the question arises, what does this mean for cryptocurrency investors? In practice, they can use this exclusion to avoid gift tax that might otherwise be payable.
Although gifting cryptocurrencies to family members may be helpful in minimizing tax obligations, it is not a way to completely avoid taxation on virtual currencies.
Therefore, you still have to pay tax when selling cryptocurrencies – provided that a profit is made. Nevertheless, this approach can be helpful to keep cryptocurrency in the family, which is a very important aspect for many investors.
Moving to another country
Taxes on capital gains from cryptocurrency investments often place a significant burden on investors. In addition to the above-mentioned solutions, there are also others to avoid taxation. One option is to move to a country that offers favorable tax rules for digital assets, and there are quite a few of them these days.
It is worth noting that moving to another country can be a complicated and time-consuming process. However, for those who invest in cryptocurrencies that are gaining in value, this strategy may prove to be a bull’s-eye.
Currently, there are many countries that stand out from others with favorable tax regulations for cryptocurrency investors. It is worth mentioning Puerto Rico, for example, a country that has a particularly liberal approach to taxes on digital currencies.
However, it is important to remember that Puerto Rico is a US territory, but it has its own independent tax laws. The most important advantage for cryptocurrency investors is the lack of taxation on capital gains obtained from investing. Thanks to this, an investor who bought a digital asset, e.g. Bitcoin, when its value was USD 25,000 and then increased to USD 220,000 will not have to pay tax on the profit.
Importantly, purchasing cryptocurrencies does not have to be done before moving to Puerto Rico, however, any unsettled profits before this process are subject to standard taxation.
There are also other countries that have attractive tax laws related to cryptocurrencies. It is worth mentioning Portugal here. This country does not charge tax on capital gains obtained from investing in cryptocurrencies. However, to take advantage of these favorable tax provisions, the investor must become a resident of Portugal – a process that takes time and formalities.
An interesting way is to buy items on Crypto Emporium using cryptocurrencies. Currently, many online stores accept payments, e.g. in Bitcoin or ETH. Using these cryptocurrencies you can buy luxury watches, cars, boats and real estate.
Although purchasing items using cryptocurrencies does not directly reduce your tax bill, it can help reduce your overall tax liability. This is especially true when digital currencies are sold at a loss. This tactic is known as “tax-loss harvesting.”
If you are wondering where exactly to make purchases using cryptocurrencies, it is worth familiarizing yourself with platforms such as Crypto Emporium. On this type of websites you can pay and accept various cryptocurrencies, e.g. BTC, DOGE or ETH.
By purchasing items on these types of platforms, you can avoid cryptocurrency tax. This is made possible by using a strategy called “tax loss harvesting”.
Donating cryptocurrencies to charity
Another interesting option to avoid paying tax on your profits is to donate cryptocurrencies to charity. This method is a quick and simple way to reduce your tax burden, especially as more and more charities accept donations in digital currencies. It is worth mentioning Save the Children US here.
It is worth noting that in the USA, donations are considered tax-deductible activities and are therefore not taxable. However, it is important that the charity to which cryptocurrencies are donated is recognized and registered in the country.
Before making a donation, cryptocurrency investors should research the organization of their choice to ensure that the funds donated will qualify for tax exemption.
Another important aspect related to cryptocurrency donations is the option to avoid taxation on potential increases in the value of the donated assets. Investors have the right to deduct the so-called fair market value of transferred cryptocurrencies from their taxable income.
The above-mentioned situation means that if an investor transfers cryptocurrencies to a charity in which the value increases from the moment of their acquisition, this difference will not be taxed.
It should be emphasized, however, that in many cases less than the entire amount of the donation may be deducted. The amount of the deduction depends on the investor’s adjusted gross income (AGI).
Offsetting profits – a way to avoid taxation
Cryptocurrency investors in many cases focus on long-term investments. Their goal is primarily to gradually increase prices, especially in the case of the most popular cryptocurrencies, e.g. Bitcoin or ETH.
When avoiding cryptocurrency tax, it is very important to consciously use losses from other investments as a way to reduce the overall tax burden in a specific tax year.
The tax-loss harvesting tactic is such that when an investor sells cryptocurrencies at a loss, it is considered a so-called capital loss that can be used to offset gains made elsewhere.
For example, if an investor makes a profit of $30,000 on his Bitcoin investment but has a loss of $8,000 on his ETH investment, he will be able to reduce his taxable gain by $8,000. This means that instead of paying tax on USD 30,000, the investor will only be taxed on USD 22,000.
This approach has been widely used for years, especially on the stock market. Many investors reduce their losses near the end of the year, when they have to pay annual income tax – this is a very popular way to reduce the tax burden.
This is not the end of the benefits of this strategy. As it turns out, if an investor does not achieve any capital gains and instead incurs a loss, it can be used to offset other income.
Currently, in the US, the deductible amount is $3,000, and what is not deducted can be carried over to the next tax year.
If you are not sure how to properly settle your cryptocurrency profits in the US, it would be best if you used the services of a tax specialist or tax settlement software. Thanks to this, you will avoid errors during settlement and minimize the risk of possible tax consequences.
A very important tax aspect often overlooked by cryptocurrency investors is tracking transactions and storing documents that confirm their value and dates. The tax office may ask you to document your transactions, so it is a good idea to keep any evidence of purchasing, selling or exchanging cryptocurrencies.
You should also be aware that tax rules regarding cryptocurrencies may change. For this reason, it is so important to stay up to date with current tax law. Every taxpayer in the US must adapt their settlements to changing regulations. Therefore, it is recommended to use the services of a tax advisor. Thanks to it, your tax return will be consistent with the facts and there will be no irregularities.
Settlement of taxes related to cryptocurrencies in the US is a complicated process that not only requires close monitoring of transactions, but also appropriate interpretation of tax regulations. If your goal is to avoid unpleasant surprises from the IRS, you should use the services of a specialist, e.g. a tax advisor or accountant.
It is also very important to systematically document all transactions related to cryptocurrencies. Doing so will allow you to enjoy peace of mind and financial security when investing in digital currencies.
There are many ways to avoid cryptocurrency taxation in the US. One of them is giving digital currencies to other people or moving to another country.