Our previous entry on the general and international taxation of Bitcoin examined several topics relevant to the taxation of Bitcoin, wherever you happen to be in the world. Before narrowing your focus to how Bitcoin is taxed within the United States, you might wish to consult the previous article for some helpful general info. Among other topics, it covers:
- The numerous advisors and apps which make it a lot simpler to maintain accurate records as well as properly complete your annual tax report. Such apps and advisors tend to be country-specific, although the good news is that plenty of help is available for Americans. For example; BitcoinTaxes is a helpful app which can automatically download exchange history, integrate with Bitcoin wallets, and provides a directory of Bitcoin tax professionals.
- The international crypto regulation and taxation agreements arrived at during the recent G20 summit in Argentina. While the effects have yet to reach the United States, increasing levels of international coordination and cooperation on such issues is likely to eventually have an impact on American Bitcoiners.
- Our previous article also tackles one of cryptocurrency’s most hotly-debated topics; whether or not to report one’s crypto profits to the taxman. As reported in February of 2018, only a tiny minority of Americans are reporting their crypto transactions to the Internal Revenue Service (IRS). However, the IRS is well aware of this widespread under-reporting. In response, the tax agency demanded thousands of client records from a popular US exchange, using this data to pursue unpaid taxes.
How Bitcoin and Cryptocurrency is Classified in The USA
Most world governments do not recognize Bitcoin or crypto as legal tender, and the US is no exception. However, most governments tend to pigeonhole Bitcoin within a single, pre-existing category. This has the effect of streamlining taxation and regulation, as the rules governing that existing class are then simply applied to Bitcoin.
However, matters are not so straightforward in the United States, as various agencies classify Bitcoin differently. Often they categorize it in such a way that they can claim regulatory power over it. For example, the Commodity Futures Trading Commission, responsible for overseeing Bitcoin futures contracts, has determined Bitcoin to be a commodity. A Federal Court confirmed this view in late 2018. The Securities and Exchange Commission (SEC) does not consider Bitcoin or Ethereum to be securities; however it does categorize many ICOs as such (which has major legal implications for token holders and issuers).
The Internal Revenue Service’s Position on Bitcoin
The most pertinent view for taxpayers is that of the IRS – and the tax agency views Bitcoin as property (specifically, “intangible property”). This view is spelled out in the guidance paperpublished on the IRS website, in which it is stated that “virtual currency” is treated as property for federal tax purposes. It’s possible that the IRS will eventually revise its view to bring it into accordance with that of other agencies.
For now, the property classification demands that Bitcoin gains or losses be calculated, logged, and reported upon every taxable event. In practice, a taxable event constitutes just about any crypto transaction or exchange.
Bitcoin’s classification as property for taxation purposes carries with it both pros and cons:
- Unfortunately, the requirement to log and report gains and losses on every transaction places rather a large compliance burden upon Bitcoin users. They must not only track all transactions but also the Bitcoin price (in US Dollars) at the time, as well as their capital gain or loss. As prices can vary between exchanges, it’s usually recommended to use an average price (such as the Gemini Bitcoin Index), except in cases where the Bitcoin is exchanged upon a specific exchange.
- The IRS caps deductible losses for property transactions at $3,000 annually. This makes it tough to offset large trading or investing losses against your overall tax bill.
- There is one major advantage to Bitcoin’s status as property. The positive aspect is that a maximum tax rate of 15% will be applied to Bitcoin capital gains, which will likely be the majority of what the average individual will report. This is 10% less than the maximum for income tax. However, active traders, crypto miners / stakers, and crypto-accepting workers or businesses can expect to pay a tax rate of up to 25% on their crypto income.
How Bitcoin is Taxed in the USA
The main tax applied to Bitcoin by the IRS is Capital Gains Tax. However, mining and receiving a wage or salary in crypto form will incur Income Tax. Further taxes such as Employment Tax, insurance and unemployment contributions will apply for employees and employers. Finally, when a self-employed individual earns cryptocurrency in the course of their business activities, they will be liable for Self-Employment Tax.
Here’s how and when each type of tax is applied:
Capital Gains Tax
As mentioned, Capital Gains Tax (CGT) has a cap of 15%. Besides the obvious case of a capital gain (or loss) derived from purchasing an amount of cryptocurrency and later selling it for US Dollars, many other transactional situations should be recorded and reported. These include:
- Making a payment using cryptocurrency. Any such payment would be reported in the same manner as when trading property for goods or services.
- Exchanging one cryptocurrency for another, for example trading Bitcoin (BTC) for Ethereum (ETH).
- Claiming forkcoins, for example Bitcoin Cash (BCH) which forked off from Bitcoin and in so doing awarded Bitcoin holders with free BCH.
The most important point to keep in mind for CGT purposes is calculating cost basis. The IRS wants to know how much you paid for your coins and at what price you exchanged them. This information usually cannot be determined from a Bitcoin wallet alone, as these tend to lump all coins together into a single balance and don’t record the USD price at the time of a transaction.
However, by selecting particular coin inputs bought at different prices for each spending transaction, it should be possible to keep your tax bill to a minimum. This will of course require detailed management and record keeping. Certain apps and exchanges will also help you to record this information. If you trade across various platforms, then an app is certainly recommended as a comprehensive solution.
The suggested accounting method for calculating cost basis is FIFO (First In, First Out), as recommended by a crypto tax expert.
Income Tax can run up to 25%. Here is how income tax is applied to the crypto realm:
- Crypto received in exchange for goods or services must be reported as income, with the fair USD-denominated market value of the crypto at the time of exchange recorded.
- When any cryptocurrency is successfully mined (or staked), that profit must be reported as gross income. As with the previous case, its value at the time must be properly reported. If mining as a business, then Self-Employment Tax will likely apply instead.
- Trading activity will be subject to income tax. As this can prove more expensive than CGT, traders should assess whether a longer term strategy, more likely to incur CGT, may serve them better once taxation costs are taken into account.
The IRS is Cracking Down on Crypto Taxation
In March of 2018, just before tax filing day, the IRS issued a “gentle reminder” to crypto users regarding their tax obligations. In their warning, the IRS warns of criminal charges for tax evasion or submitting a false tax return of five and three years in prison respectively, plus a maximum fine of up to $250,000 for both types of offence.
In February of 2018, it was reported that the IRS has assigned a team of investigators to track crypto tax evasion, amongst other violations of the law. It’s likely that those hiding fortunes in crypto form will be the focus of such investigations. When the IRS went after users of a popular American crypto exchange, it targeted over 14,000 users who profited by over $20,000 over 2 years.
Even if you only transact in smaller amounts, you can’t be certain that the IRS won’t seek to make an example of you. Given that crypto exchanges and services must increasingly share client information with the authorities in order to legally operate in the US, you should assume that the IRS knows about your crypto activities.
It’s far better to develop a smart plan, ideally with the assistance of a tax professional, to legally lower your tax obligations than it is to dodge the taxman but get caught out. The more aggressive and sophisticated the IRS becomes in pursuing crypto tax evaders, the less the financial gains of avoiding the taxman justify the inherent risk. We advise our clients to keep accurate and complete records of all their crypto activity.
This article is intended for information purposes only, and should not be taken as legal or tax advice. The author is neither a tax professional nor a citizen of the United States. We therefore recommend that you conduct your own research into the matter; the IRS site and their guidance published on crypto taxation both contain a great deal of useful information on this subject and should be considered as authoritative. Kindly consult with a tax specialist, such as an accountant or tax lawyer, should any difficulties or further questions arise.