Two years ago, Bitcoin, truly demonstrated its potential. All the hoopla, the buzz and opportunities that came with Bitcoin, it was understandably easy to forget about taxation on cryptocurrency. For tax purposes in the United States, however, just about every bitcoin or other forms of cryptocurrency; whether trading, spending, mining, or various other transactions is anticipated to be a taxable event.
It’s important for taxpayers to be proactive. This past year was precedent-setting for the Internal Revenue Service’s enforcement of gains in cryptocurrency. Taxpayers volunteering the information are usually presented with leniencies, unlike those discovered during an investigation. It’s a lot easier to make an interest payment rather than face criminal penalties.
The IRS estimates that there are many cryptocurrency users evading taxes since reporting of cryptocurrency transactions has only been in the hundreds since its introduction and usage. This is likely partially due to the unfortunate fact that the IRS has not provided clear guidelines for tax on cryptocurrency. What is distinctly clear, however, is that while many consider Bitcoin and the like to be virtual currencies, the IRS considers them to be an actual taxable item or property which your tax preparer or accountant should be disclosing. That being said, there are capital gains implications when buying, selling, spending and believe it or not, exchanging any form of cryptocurrency. Furthermore, receiving it as payment or any form of compensation is treated as ordinary income.
The way that wallets and exchanges are currently set up doesn’t allow users to have a choice regarding which coins to exchange or sell. Having information concerning the type of coin being exchanged or sold would permit taxpayers to have more control over their capital long- and or short-term gains. Provided that consistency is maintained throughout the return, taxpayers have the opportunity to choose their method, as the IRS is likely to revert to First-In-First-Out treatment, even though guidance hasn’t been provided.
Generally speaking, long-term gains are taxed at a discounted rate – depending on your tax bracket, ranging anywhere from 15 to 23.8 percent. Short-term gains, on the other hand, are taxed at the regular income tax rate. As a result, the best thing to do in order to minimize the impact is to hold any purchases made for over a year. It is, however, quite possible that locking the profit now and taking whatever tax hit can be advantageous, considering its unpredictability. If this sounds confusing, it’s because it is. That’s why it’s wise to always file tax returns with accountants.
The table below provides specific details involving the tax implications of cryptocurrency transactions:
| Transaction Type | Tax Implications |
| Air Drops | Treated as ordinary income from the moment it’s receivedit’s value established on the same day as the airdrop. If and when it is exchanged or sold, a capital gain will ensue |
| Converting Cryptocurrency to Other Currency | Cryptocurrency converted to another currency (i.e., USD) at a gain is processed as sold, resulting in capital gains, therefore, making it a taxable event. |
| Exchanging Tokens | A taxable event occurs when one type of coin is exchanged for another. Capital gains or losses occur because the token is considered sold. |
| Initial Coin Offerings | The IRS doesn’t treat these as tax-free for raising capital. Consequently, ordinary businesses and individuals produce ordinary income. |
| Mining Coins | From the day the coin is successfully mined it is treated as ordinary income equivalent to the fair market value on its day of occurrence.. |
| Payments | Cryptocurrency exchanges, whether for services, products or salary are considered ordinary income at the fair market value upon receipt of the coin. |
| Spending | Capital losses or gains might result from spending cryptocurrencies. Whether it is considered a long- or short-term gain relies on the holding period. Ex. One coin is purchased at $100. The value of the coin then increases to $200 and you purchase a gift card valued at $200, a $100 taxable gain takes place. |
| Trading | Capital losses or gains are a product of trading, with the former having the ability to reduce tax and offset gains. |
Ultimately self-reporting is your best option. If you traded in cryptocurrency, preparing tax documentation is complicated because digital exchanges are not broker-regulated by the IRS. A 1099 form isn’t issued when exchanges are made and the gains or cost basis is not calculated. In fact, several cryptocurrencies don’t even permit transactions in dollars, preferring to use Ethereum. To sum up, volunteering the information from the get-go is worthwhile, especially as cryptocurrencies continues to be used more and more frequently.
