You’re a diligent tax preparer. To you, dollars and cents tell stories of tax brackets, reportable income, deductibles and refunds.
But now, a client who holds cryptocurrency walks in the door, and you have questions. Is it an asset? Is it income? Is it taxable? If so, how?
Let’s start with the IRS, which defines most cryptocurrencies as “convertible virtual currencies.” They are a medium of exchange, and the profits they create can be taxable like capital gains.
But at tax time, there’s more to it than that. The key to accurate reporting is understanding “taxable events” related to the crypto movement. Understand the rules, and you’ll be better prepared to advise your clients on the tax implications of their forays into cryptocurrency.
What are the 4 crypto taxable events?
On their own, cryptocurrencies are not taxable. Someone who simply holds crypto is not expected to pay anything like an income tax.
However, crypto becomes taxable when it is sold or used as payment. Similar to other assets or property, cryptocurrencies create taxable events when gains are made.
In general, taxable events fall under four categories:
- A sale that earns a profit. Think of it like capital gains. The holder who bought $1,000 worth of crypto and sells for $1,500 owes taxes on the profit. Conversely, if the holder sells that $1,000 in crypto for $500, the loss is deductible. The same capital gains approach applies to cryptocurrencies exchanged — the common practice of swapping one type of crypto for another. Even on an even exchange of, for example, $1,000 in Bitcoin, originally purchased for $300, for $1,000 in Ethereum, the Bitcoin holder racks up a $700 capital gain.
- Purchase of goods or services with crypto. Sellers owe taxes on the increased value between the price they paid for the crypto and its value when it was spent. Unfortunately, this creates a double taxation for the buyer, who probably pays sales tax on the purchase. It also means documenting every purchase made with crypto — even if it’s a cup of coffee or filling the gas tank.
- Accepting cryptocurrency as payment for goods or services.
- Earning money from cryptocurrencies through mining, staking or lending. Crypto enthusiasts can make their crypto grow in three ways. These forms of earning income from cryptocurrency activities can be taxed as ordinary income. Crypto miners verify cryptocurrency transactions and add them to the blockchain. Those who stake cryptocurrencies commit their assets to supporting a blockchain network and confirming transactions. And finally, crypto holders can act like bankers, lending crypto in exchange for interest. Miners who earn crypto as part of a business can report the compensation as business income and deduct expenses for their mining operation.
How is cryptocurrency taxed?
As noted, buying, selling or exchanging crypto triggers tax consequences. Like other taxable investments, crypto gains or losses are classified as short-term or long-term. In both cases, the tax rates depend on taxpayer status and tax bracket.
Typically, short-term capital gains come from cryptocurrencies held for one year or less. Income is taxed as ordinary income at its fair market value on the date the taxpayer received it. The 2022 tax rates range from 10 % to 37%.
Long-term capital gains rates apply to crypto held for more than a year. For 2022, tax rates for long-term capital gains range from 0% to 20%.
To determine the amount of the capital gain or capital loss, calculate adjusted cost basis as the original price paid, minus any fees or commissions paid to complete the transaction. Then determine the sale amount, also adjusted to reflect fees or commissions. Finally, subtract adjusted cost basis from adjusted sale amount. Online cryptocurrency tax calculators can help simplify estimation of capital gains or losses.
Nontaxable crypto events
When is crypto not taxable? In a handful of cases, says the IRS:
- Buying cryptocurrency with government-issued currency, known as “fiat money.” As noted, tax implications don’t kick in until the holdings are sold or used in transactions.
- Donating cryptocurrency to a tax-exempt non-profit or charity.
- Gifting cryptocurrency to a third party. Similar to gifting money to a close relative, these gifts are subject to exclusions — $16,000 or less in 2022 for gifts made by an individual and $32,000 from a couple.
- Transferring cryptocurrency between wallets.
How are taxable crypto events reported?
In essence, cryptocurrency is nontaxable only if it goes untouched, or it’s gifted or donated. The IRS does not consider it a true currency but, instead, views it as property. Capital gains and losses should be reported on Schedule D and Form 8949, Sales and Dispositions of Capital Assets. Crypto-holding taxpayers should keep logs throughout the year, recording the amount of crypto spent and its market value in U.S. dollars at the time.
It’s important for holders to know that cryptocurrency brokers, which are usually crypto exchanges, will be required to issue 1099 forms to clients beginning in tax year 2023, for 2024 filings.
What are the implications of cryptocurrency?
Naturally, the IRS Tax Code is full of rules and exceptions regarding taxation of crypto. As a rising number of investors tiptoe into crypto or dive in headfirst, well-prepared tax preparers should know all the implications. Continuing professional education (CPE) courses taught by experts offers an efficient way to tap into a rapidly changing field.
Surgent Income Tax School’s CPE courses are built around timely topics, equipping participants to gain a competitive edge and build their knowledge base around crypto and other technologies impacting our daily lives and our business practices. Tax preparers who position themselves as crypto specialists can build their businesses by attracting a niche audience known for its enthusiasm.
Surgent Income Tax School can also teach you how to start and grow your own business, whether you’re thinking about converting a hobby into a real income producer or you’re ready to start hiring staff for your thriving enterprise. Visit Surgent Income Tax School today, and unlock a world of opportunities for your tax preparation business.