How is Cryptocurrency Taxed?
Currently, all the major and even most of the minor cryptocurrencies are skyrocketing. Some people consider virtual currency as better gold, and others consider it yet another bubble that can burst at any time. Only time will tell, but what the IRS (Internal Revenue Service) has recently decided is going viral on the internet. It has stated that all the convertible virtual currencies, including Bitcoin, must be considered as property instead of currency. It means that the tax will be applied whenever you trade, sell, or buy Bitcoin.
What Difference Does It Make?
It might not seem like a major distinction, but in reality, it certainly is because it determines the following:
- How will Bitcoin and all the other convertible cryptocurrencies be taxed?
- What suitable planning and methods should you use to mitigate the taxes that you will need to pay on your Bitcoin transactions?
- How will you get the information to ensure that you calculated your taxes correctly?
- Will you need to seek the services of CPAs or tax experts to make sure that you fall on the right side of the law?
This article will answer these questions, and it will also help you understand how Bitcoin is taxed. So, keep reading to make sure that you take your next steps in the right direction to pay your Bitcoin taxes.
Virtual Currency and the IRS
The IRS has said that cryptocurrency is that which doesn’t offer any legal tender status in the jurisdiction. If any cryptocurrency can be used as an alternative to real currency or offers an equivalent of real currency value, then it will be considered as convertible virtual currency. Moreover, it can be traded digitally, and it can also be converted into any other type of real currency.
When Will Taxes Be Applied to Your Bitcoins?
The IRS has also said as Bitcoin, and other convertible cryptocurrencies such as Dogecoin will now be treated as property, which means that all the general tax principles will be applied. So, if you are being paid in Bitcoins or other cryptocurrencies for the services or products that you offer, you'll need to add it to your gross income by converting the cryptocurrency into US dollars at fair market value. In simple words, regardless of your cryptocurrency, whether it’s Bitcoin or any other, all the transactions will be reported in US dollars.
Moreover, the IRS also added that the exchange rate that you’ll use to convert the virtual currency to US dollars must be of that time when the cryptocurrency is received. You can check the current exchange rate by going to any of the official cryptocurrency websites. Not only will it help you to save time, but it’ll also allow you to avoid all unwanted situations. If you dispose of Bitcoin, you'll also have a capital loss or capital gain. It's because of the same reason as bitcoin is now considered as property, and taxes are applied as well. Even if you're paid for your services or good in a virtual currency, that is simply your income which in all cases is taxable. That's why all the transactions in Bitcoin are now taxable.
A specialized tax attorney, Tyson Cross, states that if you are a Bitcoin user, then you'll need to calculate your loss or gain every time you make a transaction.
Just like all the other types of property, you’ll need to acquire Bitcoin(s) first by paying cash. Then you’ll become its owner as with other property types for the time being, and then you'll eventually trade it, sell it, give it away, or dispose of it. At this point, the capital taxes come due. You must understand the following points when you dispose of your property.
- Your income will be determined by your gains.
- Your gain will be determined by converting the Bitcoin(s) according to the current exchange rate when you receive them.
- The amount of tax that will be applied to your Bitcoin property will be determined by measuring the amount of time you hold it. If it's more than a year, then it will be considered as a long-term gain, and if it's equal to one year or even less, then it will be considered as a short-term gain.
- Schedule D and Form 4797 or Form 8949 will be used to report your property disposition on the tax return. You’ll need to show your math by calculating your loss or gain as it’s required for the forms mentioned above. It’s also important to bear in mind that all the calculations must be accurate and precise according to the instructions.
Capital Gains Tax Example
Let’s discuss a scenario to understand the capital gains tax in a better way. Assume that you bought bitcoins by spending $10,000 USD, and you sell them at $15,000. It simply shows that you earned the capital gain of $5,000. If you keep the $5,000 for a year or less, then it will be your short-term gain. So, you'll need to pay tax for it according to your applied tax bracket as your ordinary income. On the other hand, if you keep the $5,000 for more than a year, then it will be considered a long-term gain. And depending upon your overall income, you'll need to pay tax for it at a 0, 15, or 20 percent rate.
If you opt for market-to-market trading, then all of your gains will be considered short-term gains. Moreover, you'll need to report them by using the 4797 Form, and all the expenses related to your Bitcoin will be deductible on Schedule C.
Net Investment Income Tax
The net investment income tax is 3.8 percent which is applied to the investment income. You might also find that the same is applied to you as well. If your overall MAGI (Modified Adjusted Gross Income) is more than $200,000 USD per year, including all sources, and you’re also a single taxpayer, then the net investment income tax will come due. This threshold goes a little further for the married taxpayers to $250,000 who file joint returns. On the other hand, the threshold drops for the married couples to $125,000 who file separately. The additional 3.8 percent tax rate is not applied to most self-employment income and wages but only to investment income.
Paying Your Taxes on Bitcoins
We recommend you develop a bookkeeping accounting system to track all your transactions. It will allow you to monitor everything from acquiring the Bitcoin to disposing of them and then identify the method of your cost basis. The next step is to record the Bitcoin disposition by measuring the right exchange rate on Form 8949 and Schedule D. You can make sure that you measured the income accurately by detailed and comprehensive bookkeeping of your transaction records.
In order to make sure that you understand all the concepts deeply, we recommend you hire a tax professional. This way, you will be able to document your gains and losses accurately to find out your taxes. Unless you request from the IRS for a six-month extension, you need to report your income on your tax return, which is due on the 15th of April.
Consequences of Not Paying Your Bitcoin Taxes
The standard results of not paying your due taxes are also applied to Bitcoin as well, since they are now one and the same. You’ll be held accountable even if you don’t know that you need to pay taxes on Bitcoin.
It’s important to keep in mind that just like all the other financial scenarios, the IRS will know all of your activities. At least, it can check everything you’re doing when it needs, and it can easily monitor your Bitcoin transactions. That’s because all of them are stored publicly on the Bitcoin network.
If you refuse, forget, or neglect to pay your taxes on your Bitcoin income, the IRS will undoubtedly send you a notice. Moreover, you’ll also have to pay the interest at a 0.5 percent rate on the total amount of tax that you need to pay and up to the unpaid balance cap of 25 percent. You’ll also be fined at a 5 percent rate per month (according to 2020 rates).
The IRS has different types of law enforcement techniques to collect tax from levies on your bank accounts and income to liens on your property.
Tax Tools for Bitcoin
In order to make the selling, trading, and buying experience regarding Bitcoin seamless, there are lots of risk minimization tools available. We recommend you consider using any of the tools offered by reputable providers of Bitcoin wallets. Even if you have no taxes due, you must also understand all the security features that wallet providers offer to avoid unwanted situations.
These security tools will help whether you want to plan for your taxes or you want to make any transaction. BitcoinTaxes is one of the most famous web-based tools that you can use to calculate your gains and losses.
FUTURE IMPORTANT DEADLINES
Deadline for businesses to mail Forms 1099 and 1096 to the IRS
Deadline for S-Corporate tax returns (Form 1120-S) for tax year 2020, or to request an automatic six-month extension of time to file (Form 7004) for S-Corporations that use the calendar year as their tax year, and for filing Partnership tax returns (Form 1065) or to request an automatic six-month extension of time to file (Form 7004)
Deadline for businesses to e-file Forms 1099 and 1096 to the IRS, except Form 1099-NEC
Deadline to file individual tax returns (Form 1040) for the tax year 2020 or to request an automatic extension (Form 4868) for an extra six months to file your return, and for payment of any tax due, and for Deadline for corporate tax returns (Forms 1120 and 1120-A) for tax year 2020, or to request an automatic six-month extension of time to file (Form 7004) for corporations that use the calendar year as their tax year
Deadline for household employers who paid $2,200 or more in wages in 2020 to file Schedule H for Form 1040
Deadline for first-quarter estimated tax payments for the 2021 tax year
Deadline for second-quarter estimated tax payments for the 2021 tax year
Deadline for third-quarter estimated tax payments for the 2021 tax year
Deadline for S-Corporate tax returns (Form 1120-S) for tax year 2020 for S-Corporations that use the calendar year as their tax year, and for filing Partnership tax returns (Form 1065)
Final extended deadline to file individual tax returns for the year 2020 (Form 1040), and for Deadline for corporate tax returns (Forms 1120 and 1120-A) for tax year 2020 for corporations that use the calendar year as their tax year