Recent periods have been a busy time for cryptocurrencies, even amidst the global pandemic. Bitcoin, which is the largest cryptocurrency as per the market value, initially skyrocketed before fluctuating widely towards the end of 2020 and the start of 2021. Other cryptocurrencies, such as Tether, Ethereum, and Ripple, have also increased in popularity as the general public becomes more comfortable with these currencies.
Like other investments, the IRS has been watching the cryptocurrency market and has recently introduced taxation measures. As such, if you have traded cryptocurrency, you should understand how mining, buying, and selling these assets affects your tax liability.
What Is Cryptocurrency?
Cryptocurrency is a digital currency that can be used to store value or as a medium of exchange. This currency doesn’t have physical tokens, like coins or dollar bills, and lacks centralized government control. Instead, this digital currency relies on deeply encrypted and distributed ledgers called blockchain technology.
Cryptocurrencies have appealed to many people as they provide secure transactions without influence from the central government. Bitcoin, which was the first cryptocurrency, was launched in 2019. There are now thousands of cryptocurrencies in circulation, including Litecoin, Ripple, Dogecoin, and Bitcoin Cash.
Tax Considerations for Cryptocurrencies
The growing acceptance of cryptocurrencies as mediums of exchange has attracted the attention of many people and agencies, including the IRS. In 2014, the IRS issued Notice 2014-21 which classified cryptocurrencies as capital assets like bonds and stocks. The ruling determined that cryptocurrencies would be taxed as property, and not as currency.
This decision brings forth serious implications for cryptocurrency owners, as it exposes them to several complicated tax requirements. Capital assets are taxable if profits are realized. Therefore, if you purchase products or services using cryptocurrency and the value of the cryptocurrency that you used increases over time, your transaction incurs a capital gains tax.
How Much Do You Owe the Government?
The amount of cryptocurrency taxes owed to the government generally depends on your yearly income from cryptocurrency and the amount of time you’ve had your crypto coins. Here are some important points to consider:
- If you have owned cryptocurrencies for some months before selling or spending them, any resulting profit is considered short-term capital gains and taxed using the normal income tax rates.
- On the other hand, if you stored your coins for more than a year, any resulting profit is considered long-term capital gains and is taxed at a lesser rate depending on your annual income.
- Taxes for cryptocurrencies earned by mining, received as promotions, or given as payment for goods and services are calculated using the normal regular taxable income rates.
- You should also pay taxes if you convert or exchange cryptocurrencies. For instance, if you swapped Bitcoin for Ethereum, you should pay taxes for the profits earned from the transaction.
In summary, you owe the IRS cryptocurrency tax depending on how you acquired and used your coins.
The Bottom Line
While cryptocurrency taxes may seem complicated, you shouldn’t take shortcuts when dealing with them. The IRS has intensified its regulation and enforcement of cryptocurrency transactions. Therefore, ensure that you include any crypto transactions on your tax returns to remain in good standing with the IRS.