As with most investments, there will be taxes to consider before determining how much you’ve really earned – or lost – on your digital assets.
So if you couldn’t resist participating in, say, bitcoin’s mad dash – which, for those keeping score, is more than 50% below its all-time high – keep an eye out. mind the following.
Before you can determine your tax obligations, you must first be clear about what is considered a taxable event when it comes to buying and selling crypto.
Purchase and holding: Simply buying and holding virtual currency such as crypto is not taxable. And you don’t have to report the details on your tax return, according to the IRS, just like you wouldn’t report a stock or other asset you bought and hold in a brokerage account. (Although in this example you would report any dividends or interest earned from the investment.)
But what do you do with your crypto after your first purchase, it may be a taxable event.
Using crypto to pay for things: In the United States, you can use cryptocurrency to purchase products or services. But it is not treated as cash for tax purposes. Instead, it is considered a property.
To make matters more confusing, using crypto to buy something technically counts as selling your crypto. You must therefore declare any capital gain or loss on this sale, which will be determined by the difference – in US dollars – between the amount you paid for the currency and its value when you used it to buy something.
If you held the crypto for a year or less and has appreciated in value, your capital gain will be taxed as ordinary income. If you hold it for more than a year, then it will be subject to capital gains tax rates.
If it has lost value, you can use that capital loss to offset any capital gains you have made on other investments.
Get paid in crypto: If you are paid in bitcoin or any other digital currency, this will be treated as taxable income for you. The declared amount must be the fair market value in US dollars of the virtual currency on the day you received it.
Pay someone in virtual currency: This is treated as selling your currency on which you will realize a gain or loss. The IRS notes that the gain or loss is determined by the difference between the fair market value of the good or service you purchase and your adjusted basis in the virtual currency used in the transaction (i.e., which is calculated using your original cost to buy the currency and any fees or commissions you paid to do so). Here’s an oversimplified example: if you paid someone in bitcoin for a plumbing job of $1,000 and the base cost of bitcoin was $500, you would have a capital gain of $500 on which you owe tax.
In all these cases, if you do not pay the tax you owe, you will be liable for interest and penalties and, in certain circumstances, even criminal prosecution.
Will my state tax my crypto transactions?
Don’t forget state taxes.
“Most states haven’t specifically addressed virtual currency, which means the majority of states that have income tax would follow the federal lead,” Luscombe said.
Any money you earn from your crypto investments or income payments will count towards your adjusted federal gross income. And most states use your federal AGI as a starting point.
Two states – Nevada and Wyoming, neither of which has income tax – specified they would not subject virtual currency transactions to state property tax, Luscombe said.
(For more information on these and other questions, the IRS has created this FAQ. And if your situation is particularly complex, consult a tax professional experienced in this area.)
New reporting requirements at your fingertips
Currently, you are still responsible for keeping all records of your crypto transactions and reporting those that are taxable to the IRS. You will also be asked to certify at the top of your Form 1040 whether you received, sold, sent, exchanged, or otherwise acquired a financial interest in virtual currency during the tax year.
But the IRS didn’t just take your word for it. For example, any business paying more than $600 to a nonemployee or paying a salary to an employee must report that income to the IRS, said Mark Luscombe, senior federal tax analyst for Wolters Kluwer Tax & Accounting. If you do not report this income you have received, you could be subject to an audit and/or a penalty for under-reporting.
But from the tax year 2023, everything of your potentially taxable digital asset transactions will be reported to the agency by third parties.
This is no different from third party reporting requirements that are in place when you are employed or invest in stocks. You and the IRS get a W-2 a form from your employer that reports your annual income and a Form 1099 from your broker that reports your stock trades.
In an effort to make money laundering harder, next year a business must report to the IRS anytime it receives more than $10,000 worth of cryptocurrency in a single transaction (or two or more). several related transactions), just as it must do when it receives money. above this threshold. Failure to do so willfully can be prosecuted as a federal crime.
You can’t stay anonymous
The new reporting requirements represent a potential benefit for crypto investors in two ways: they are a sign that crypto is here to stay. And given the headache of trying to keep track of all your transactions, getting a 1099 can prove useful.
But the downside will be a loss of anonymity for those who want to keep their transactions private or who haven’t met their tax obligations.
When you open a bank or brokerage account, you need to provide a lot of personal information that is cross-checked to confirm that you are who you say you are. You must provide your legal name, address, telephone number, and a social security number or other tax identification number, among others.
But when setting up crypto-related accounts, the information you’re asked to provide varies by platform.
“Until this year, it was quite common to open [an account or digital wallet] with a name and email address,” said Erin Fennimore, information reporting manager at TaxBit, a cryptocurrency tax software provider.
In 2023, this will change in many cases. “You’re going to be asked for personal information that you probably haven’t been asked for in the past,” Fennimore said.
And the platforms required to report your transactions will have to verify your identity.
Additionally, when a digital asset is transferred from one broker to another, the transferring broker will need to issue a statement to the receiving broker that includes information about the basis and holding period of the transfer. crypto so that the receiving broker can meet their 1099 reporting requirements.
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Taxation of Cryptocurrencies: Here’s What You Need to Know
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