Cryptocurrencies have infiltrated the public market considerably since their inception. As such, taxes on cryptocurrency have increasingly become the norm as governments and institutions assert more control over these new assets.
In light of this, the current article will look at when you can get taxed on cryptocurrency. Specifically, it will look at the move toward taxation, and regulations that have been put in place across the world. This should assist in making you aware of any tax pitfalls out there.
Can You Be Taxed On Cryptocurrency?
The short answer to the above is yes. But it’s not quite as simple as that. Below we’ll quickly look at the issue of taxes on cryptocurrencies, and why there is a push for its adoption.
The Institutional Concerns About Cryptocurrencies
To start, cryptocurrencies and governments have had a tense and intriguing relationship. Bitcoin in particular, due to its renowned status, has been in the firing line as an easy target.
There are a few concerns that crop up time and again. Firstly, there is the issue of cryptocurrencies and their well-known market volatility. Understandably, governments are wary of mass investment in risky cryptocurrency options.
Secondly, officials have concerns ceding control over monetary and/or fiscal policies. Effectively, officials would be ceding control to an algorithm and those who maintain it. This is a difficult and bitter pill to swallow.
Thirdly, there are the ever-present alleged associations with criminal elements that give pause to open adoption, and mainstream acceptance, of cryptocurrencies.
The Shift To Cryptocurrency Taxation
Despite these clear and occasionally justified worries, the resilience of many cryptocurrencies over time has forced a reappraisal of the crypto system. Not only has it been resilient in some fashion, but blockchain payments are also far quicker and more cost-effective than traditional transactions. Not to mention the security of the blockchain system in general.
For these very reasons, there has been a gradual tolerance of cryptocurrencies, to the point that they are slowly being inducted into more conventional financial systems. Popular exchanges, such as Coinbase and Binance, have made it easier to shift from cryptocurrencies to fiat, and have grown the userbase accordingly.
The increased prominence of cryptocurrencies on more traditional markets is evidenced by the existence of futures contracts, amongst others. As there is a tacit acceptance of these cryptocurrencies, and seeing as they have made progress into traditional markets, it’s understandable that there is an increased institutional pressure to regulate and set taxes on cryptocurrency.
For example, the US’s Internal Revenue Service (IRS) has recently started mailing taxpayers that have been trading in virtual currency. It’s suspected and alleged that these taxpayers owe the government back taxes. The IRS maintains that those who do not comply could face a range of measures, from penalties, interest, and even jail time.
Taxes On Cryptocurrency
Due to governmental actions such as these, what does this mean for the average crypto trader?
Using Bitcoin as an example; it was originally touted as an anonymous ecosystem. Nowadays, however, the majority of transactions are transparent. While previously there were certainly increased instances of illicit trading of Bitcoin, this has decreased dramatically since many crypto exchanges have stepped up to impose regulations of their own. There are now anti-money laundering requirements to avoid perceived overregulation from governmental institutions.
Despite all of these alterations to the cryptocurrency ecosystem, the biggest for the average trader has been the rise of taxes on cryptocurrency. Regardless of whether it has been classified as a currency or some form of commodity, the general consensus by regulators, bankers, and judges is that cryptocurrencies should be taxed. As a result, the majority of countries do tax them.
Specifics On Taxing Cryptocurrencies
Regardless of the threat of taxation (or regulation more broadly), you needn’t worry unduly until these notions have been put down into law. Despite what specific regulators may say, or how they view cryptocurrencies in general, they do not have the power to override how your assets are defined or to change tax code. Traders should take heart that nothing much has changed since the IRS (as an example) addressed the issue of cryptocurrencies in 2014.
Sticking with the IRS, due to their prominent role alongside one of the most important financial markets in the world, they define any digital currency as a property. Effectively, this means that if you were to purchase anything using this digital currency, it would be taxable as a capital gain (this is both in the long or short term).
To make this clearer, if you were to buy anything with Bitcoin purchased back in the day at $1,200, you would also need to take into account what the price of Bitcoin is during the moment of purchase. If, say, Bitcoin is currently trading at $1,500 during the moment of purchase, this jump in worth will be taxable according to the rules of capital gains.
Effectively, according to the IRS, cryptocurrency traders are meant to disclose their earnings. If this is not done, you could be charged with tax evasion.
The following are a few types of cryptocurrency transactions that are deemed taxable according to the IRS.
Firstly, exchanging any cryptocurrency for fiat (also known as “cashing out”), is an obvious taxable event.
Similarly, a second taxable example is the exchange of one type of cryptocurrency for another.
A more idiosyncratic form of taxation is accrued when you receive mined cryptocurrency.
And, finally, a fourth example of a taxable event is when you pay for any goods or services, such as paying toward the muffin in your favorite coffee shop.
While the above seems to cover the entire range of possible transactions where taxes on cryptocurrency could be incurred, some events are not deemed taxable, at least according to the IRS.
Buying cryptocurrency with your fiat money is interestingly not a taxable event. This means that you can buy cryptocurrencies to start trading and not be taxed. But as soon as you cash out or trade for other cryptos you will be.
Other examples of non-taxable transactions are when you gift crypto to a third party, or when you donate to tax-exempt institutions (such as charities and non-profits). Another important example is that the movement of cryptos between your wallets is not taxable.
Calculating What Is Owed
Determining your liability with regards to any taxes on cryptocurrency is not a straightforward process.
Exchanging Cryptocurrency For Other Currencies
If you were to cash out of a cryptocurrency for whichever fiat denomination you wish, it’s important to know the price of the crypto when it was both bought and at the moment of the transaction. The difference between when it was bought and when it was exchanged is taxable, similar to income tax in the short term.
Longer-term transactions are taxed according to the trader’s tax bracket.
The above applies to trading one crypto for another as well.
If you were to sell cryptocurrency that you’ve mined, you will be taxed similarly to business income. This is because you have literally performed work to earn these digital assets, and your profit is taxed accordingly.
The good news is that you can deduct any expenses that went into the crypto mining operation, such as electricity and hardware, similar to “regular” work done.
Buying Goods and Services
Working out taxes on cryptocurrency when buying goods and services can be complicated. One must first know the difference in the price of the crypto from when it was bought to the moment of the transaction, similar to the above in the case of currency exchanges.
If you were to work out the difference in the price of your cryptocurrency every time you made a purchase it could end up being incredibly tedious. And this is especially so if you frequently buy goods and services with your currency.
Even worse, there are no small transaction tax exemptions. This means that it’s incredibly costly and difficult to legally use cryptocurrencies to buy goods and services (as things currently stand).
Asking For Expert Advice
It should be noted that many crypto exchanges assist in accounting for taxes on your crypto via wealth management tools. However, these are still complicated enough that it’s advisable that you use a certified accountant when first filing your taxes on cryptocurrency. Luckily, more advanced revenue services are also helping people amend their tax returns to include any cryptocurrency transactions.
In other words, there are increasingly fewer excuses to avoid paying taxes on cryptocurrencies. Revenue services across the globe are plugging up the gaps, and crypto exchanges are assisting in declaring your taxes.
To summarize, this article has looked at whether traders have to pay taxes on cryptocurrency. It started by tracing the movement toward taxation, before listing a number of both taxable and untaxable events when trading. It then highlighted the complexity of calculating your taxes on every cryptocurrency transaction.
As the above has hopefully shown, you can’t avoid paying taxes on your digital crypto assets going into the future, and you should therefore start understanding the intricacies as soon as possible.