While tax filing day may still be several months away, precisely on April 18, 2023, it is imperative to start preparing if you have engaged in activities such as purchasing, selling, trading, earning, or losing cryptocurrency this year.
CoinDesk has sought the expertise of tax professionals to address the frequently asked questions regarding the intersection of cryptocurrencies and tax obligations in the United States. Here is a brief summary of the interview:
How does the IRS know you own crypto?
Cryptocurrencies, including non-fungible tokens (NFTs), have been classified as “property” for tax purposes in the United States since 2014, as determined by the Internal Revenue Service (IRS). Consequently, most taxable activities involving digital assets are subject to capital gains tax, similar to the taxation of stocks.
In 2022, the federal agency adopts two primary methods to ensure compliance. The first method entails self-reporting. The U.S. Individual Income Tax Return form, specifically Form 1040, includes a question that asks taxpayers if they have received, sold, exchanged, or disposed of any virtual currency during the previous year. Taxpayers must truthfully respond by checking either the “Yes” or “No” box, as this serves as the initial line of defense utilized by the IRS. Noncompliance with this requirement is subject to penalties and perjury charges, as explained by David Kemmerer, Co-Founder and CEO of CoinLedger.
The anonymous nature of cryptocurrency transactions poses challenges for the IRS in obtaining information about taxpayers’ activities. To address this, they employ the legal system and issue “John/Jane Doe Summons.” These subpoenas compel crypto brokerages to disclose user data to the IRS, aiding in the identification, auditing, and prosecution of individuals who evade their tax obligations on crypto gains. Mark Steber, the chief tax information officer at Jackson Hewitt, highlights the IRS’s improved tactics in obtaining information from broker-dealer houses involved in such activities. Notably, companies like Kraken and Circle have previously received such summonses to ensure proper tax reporting by their customers.
Following the passage of the U.S. Infrastructure Bill in November 2021, crypto broker-dealers will be obligated to report their customers’ transactions to the IRS for the year 2023 and subsequent years. This requirement further strengthens the IRS’s access to crucial transaction data, facilitating more effective tax enforcement.
How much do you have to pay in taxes?
Determining the amount of cryptocurrency tax owed in the United States involves considering the duration of asset ownership prior to disposal and the specific income tax bracket applicable to the taxpayer.
For short-term capital gains, which apply when cryptocurrencies are held for 12 months or less, the capital gains rate aligns with the individual’s ordinary income tax rate. This rate depends on the taxpayer’s overall income.
Conversely, long-term capital gains arise when cryptocurrencies are held for 12 months or more, resulting in a significantly lower tax rate compared to short-term gains. In most cases, taxpayers will not exceed the 15% rate for long-term capital gains.
Can you write off a crypto loss?
Indeed, as David Kemmerer pointed out, many individuals may find their investment portfolios in a negative position. In such circumstances, it is advisable to strategically utilize capital losses to mitigate the impact of capital gains tax and effectively reduce the overall tax liability.
Allow me to provide an illustrative example: Suppose earlier this year, in 2022, you acquired bitcoin and subsequently sold it, generating a substantial gain of $10,000. This gain qualifies as capital gains and is subject to taxation. However, you also made an impulsive investment in dogecoin when it experienced a surge after Elon Musk tweeted about a Shiba Inu dog. Unfortunately, the value of dogecoin quickly declined, resulting in a loss of $3,000 in this speculative cryptocurrency.
To optimize your tax situation before the year concludes on December 31, 2022, you decide to sell your dogecoin at a loss and convert it into cash. By doing so, you can effectively offset the $3,000 loss against the $10,000 gain from bitcoin, which was acquired during more favorable market conditions. Consequently, you will only be liable for short-term capital gains tax on the remaining $7,000.
It is important to note that you can offset up to $3,000 of cryptocurrency losses annually. Any losses exceeding this limit can be carried forward and applied to future tax years.
How are crypto gifts taxed?
According to Mark Steber, the Chief Tax Information Officer at Jackson Hewitt, gifting virtual currency operates similarly to gifting stocks, bonds, or any other capital asset. As such, the same principles apply.
When it comes to crypto gifts, they are not subject to taxation at the time of the initial transfer from the original owner to the recipient of the gift.
In the United States, gifts valued up to $16,000 per individual recipient or $32,000 per married couple remain exempt from taxation during the 2022 year. It is worth noting that this threshold will be increased to $17,000 in 2023. If you are either the recipient or the potential provider of cryptocurrency gifts that exceed this limit, it is advisable to seek guidance from a tax professional who can provide insights into the associated tax implications.
How are earnings from mining taxed?
The Internal Revenue Service (IRS) explicitly states that taxes on mining earnings are categorized as income tax. These taxes are determined based on the fair market value of the cryptocurrency on the day it is received.
To provide an illustration, let’s consider a scenario where you are operating a bitcoin mining rig and, on June 12, 2022, you successfully earn one bitcoin. At the moment this bitcoin is deposited into your wallet, its fair market value is assessed at $25,000. Consequently, you have effectively realized $25,000 of income, which necessitates its reporting as such on your tax filings.
Furthermore, if you choose to subsequently sell, trade, or utilize any portion of that one bitcoin, you may also be liable to pay capital gains tax if the selling price exceeds the value at which you initially received it.