Are you unsure about how crypto tax works in the US? The reality is that the Internal Revenue Service (IRS) guidelines are evolving, which may incentivise behaviour such as “I’ll pay my tax when the IRS finalises their guidelines”. However, new legislation from last November requires brokers and crypto exchanges to notify the IRS directly of crypto transactions, closing a loophole that enabled some investors to hide their gains.
How will the IRS know that I hold crypto and may therefore be liable to pay tax?
All major crypto exchanges must complete KYC (Know Your Customer) checks. Furthermore, many exchanges are now sending 1099 forms to the IRS, which may assist in notifying them. It is also the case that exchanges possess banking information where they accept fiat payments in exchange for crypto. Essentially, your information may be easily attainable by the IRS, should they wish to do so.
How is crypto taxed in the US?
Currently, crypto in the US is taxed as either capital gains or income. A capital gain or loss is the difference in value from when you acquired your crypto to when you disposed of it. Capital gains may occur during the following events:
- The sale of crypto for fiat currency
- Trading crypto for crypto
- Expenditure of crypto on goods and services
Crypto tax as capital gains.
The cost basis is the first important thing to consider when calculating capital gains. This is essentially what it costs you to purchase your crypto asset, including any transaction fees.
The following is a useful example of how to calculate crypto gains: Let’s say Jane buys 2 ETH in June 2021, valued at $8 000 and pays a 3% transaction fee. The cost basis is, therefore, $8 240. If she decides to sell 2 ETH for $10 000, Jane will have to calculate whether she made a capital gain or loss, so she will subtract her cost base from her sale price as follows:
$10 000 – $8 240 = $1 760
Therefore, she made a capital gain of $1760, which is taxable.
An important distinction should be made between short-term vs long-term capital gains. If you hold crypto for less than a year, you’ll pay the short-term capital gains tax based on your regular income tax rate. Long-term Capital Gains Tax for crypto is lower for most taxpayers. Depending on your income, you’ll pay a 0%, 15% or 20% tax rate.
Crypto tax as income.
Crypto income is taxed as ordinary income at its fair market value on the date the taxpayer receives it. Fair market value refers to the price an asset would sell for on the crypto market. The parties involved in the transaction act in their interest and are free of any pressure to buy or sell a particular crypto asset.
Here are the most common examples of what is considered crypto income in the US:
- Receiving crypto as payment for providing a service
- Mining crypto and earning rewards
- Staking crypto and earning rewards
- Lending crypto and receiving interest payments
Crypto tax breaks and transactions that are not subject to tax in the US.
In terms of tax breaks, taxpayers in the United States can benefit from an annual $ 16 000 gift tax exclusion per person in the year 2022. Furthermore, if you earned less than $40 400 total income (including the value of your crypto) in the 2021 financial year, you will pay no capital gains tax on long-term gains. Finally, if you HODL your crypto for more than a year, you will pay a lower long-term capital gains tax rate of between 0% and 20%, depending on your income.
Crypto transactions that are not subject to crypto tax include the following:
- Donating crypto to charity
- Creating an NFT
- Moving crypto between your personal wallets
- HODLING crypto
- Purchasing crypto with fiat currency
- Providing crypto to an individual as a gift (assuming you have not reached the lifetime gift limit)
How do I go about calculating my own crypto tax?
Should you wish to calculate your own crypto tax in the United States, you can follow the following process:
- Identify all your taxable crypto transactions for the financial year you’re reporting on.
- Identify which transactions are subject to Income Tax and which are subject to Capital Gains Tax.
- Identify the cost base for each transaction using your chosen accounting method.
- Calculate your subsequent capital gains and losses, income and expenses.
You’ll need to report all taxable crypto disposals, the proceeds from your disposal, the subsequent capital gain or loss to the IRS, and any income from crypto.
The crypto taxation framework in the US is constantly evolving. While there are ways to limit your tax burden, it is ultimately the case that once this burden is limited within a legal framework, compliance will prevent a lengthy and costly process of being compelled to pay up later due to illegal activity. We can help you with the tedious task of calculating your crypto taxes; contact us here. View our packages here.