Crypto Tax Basics: Reporting Crypto Income & Capital Gains

Cryptocurrency and Web 3 applications have sumptuously grown at the roots of 21st-century minds. People are using cryptocurrency projects as the primary source of income. Crypto projects are working without a centralized authority agency. Peer-to-peer validation is the process used in this system. Most countries consider crypto as a valid coin and often treated as personal property.

The decentralized nature of cryptocurrency and crypto projects eradicates the presence of central authority. But that doesn’t mean the assets accumulated from these projects will not come under the tax payable sector. Token holders need to pay the required taxes based on their Cryptocurrency possession.

Tax is a compulsory contribution to the government, which is used for essential services, social programs, education, and infrastructure development. In this article, we aim to create a comprehensive awareness about crypto tax and how it works. Consider this record as a complete guide to enhance your understanding of the crypto world.

Is cryptocurrency a taxable property?

Internal Revenue Service(IRS) considers cryptocurrency as a property that can come under the tax system. This indicates that those who possess crypto coins or tokens must pay the crypto tax to the government based on their activity. There are few exceptions in the crypto tax, apart from that, every transaction will come under the tax rules in the same way it applies to the other property tax. According to the tax rules, all income is taxable and that too includes in the form of cryptocurrency transactions.

The main issue regarding the cryptocurrency tax is the lack of awareness among the people. Taxpayers do not have the appropriate understanding and knowledge of crypto tax obligations. Another issue regarding the crypto tax payment is the decentralized nature of crypto projects and the anonymity of the participants who are involved in this process. This anonymity hinders the process of third-party reporting. Active cryptocurrency users not reporting their cryptocurrency transactions to avoid tax complexities is another major issue in this area. Eradicating all these issues and equipping the users with enough knowledge can only resolve the problematic scenarios related to the crypto tax system. 

Internal Revenue Service can levy penalties and can judicial system can imprison the users who did not pay the appropriate amount as tax based on their digital assets. A 75% tax due and an additional $10,000 is the penalty that can be imposed on the non-payable users. The judicial system can punish the users for up to 5 years for tax evasion. Besides this, the IRS can increase scrutiny of users who don’t report the transaction details to them, which can lead to further audits.  

What is cryptocurrency taxation?

Cryptocurrency taxation means the legal requirement or obligation from the people who possess the cryptocurrency coins or tokens to report and pay taxes on their cryptocurrency transactions. The taxation happens because governments and the IRS consider cryptocurrency as property rather than mere digital currency. So all the transactions users engaging with it are obliged to pay tax to the authority.

Cryptocurrency is a growing system, its relevance and the number of people entering the field are increasing day by day, so the authorities consider crypto coins or tokens as property. This classification makes cryptocurrency transactions similar to that of stocks, real estate, and other investments.

It is a complex process, but a comprehensive understanding of the Cryptocurrency tax system should be an inevitable one for investors and cryptocurrency enthusiasts. People can reduce their tax burden related to cryptocurrency transactions by knowing the tax rules and how they work for different types of transactions, keeping accurate transaction records, and using strategies for tax efficiency. Another important one of the cryptocurrency tax scheme is staying informed about the ever-changing regulations and governance.

How Do Cryptocurrency Taxes Work?

Everybody who has digital assets like crypto coins ought to pay the crypto tax to the government. Cryptocurrency tax is a complex process and it requires a lot of attention and comprehensive study to become a master of it. It is a complex process because the entire tax system depends upon how you acquire the coin, and how you are using the coin.  

Crypto tax works have so much resemblance to the general tax system. However it has that much similarity, certain things are different in the crypto tax system. The crypto tax system works based on some specific taxable events. 

Taxable events

• Selling cryptocurrency for paper money(fiat currency)
• Trading one cryptocurrency for another cryptocurrency
• Staking 
• Participating in proof of stake consensus 
• Cryptocurrency gifts and donations
• Receiving cryptocurrency as payment for goods and services
• Initial coin offerings(ICO)
• Security token offerings 

These are the only considerable events for cryptocurrency tax payment. To determine whether you should pay the crypto tax or not, the value of your cryptocurrency possession should be increased along with these conditions.

Cryptocurrency is considered taxable and classified into two based on the mode of acceptance or mode of transaction. Cryptocurrency as taxable capital gains and taxable as income are the two modes.

Taxable as income

If you receive cryptocurrencies from your employer in the form of salary or anything. The cryptocurrency in your possession will be taxed and come under the income tax bracket. If you accept cryptocurrencies as a payment or reward for a service or good, then you have to report it. According to IRS conditions, this can be considered as income. Staking rewards are considered as income and an amount should be paid to the authority in the form of tax.

The taxable amount will be based on the market value of your rewards. Mined cryptos will come under the tax payable section. Users need to pay tax as per the market value of the mined coins. It is considered as a self-employment income, so all the tax payable conditions are applied to it. Users will earn different kinds of rewards by holding some crypto coins. This is a taxable income. Other rewards and incentives from the cryptocurrency transactions or activities need to be reported as income and pay the required amount as tax. 

Taxable as capital gains

Capital gains tax is a kind of tax that is based on the profit from the sale of an asset. Cryptocurrencies that provide capital gains will come under this tax scheme. If you sold your cryptocurrency in possession for cash and you got any profit from the transaction.

Then you need to report it and pay the tax. The conversion process of one crypto from another can come under the tax payable scheme. All the airdrop rewards will come under the tax scheme. Airdrop rewards are part of the promotional strategy. These airdrop rewards need to be reported to the IRS.

Non Taxable Events

• Buying the cryptocurrency with fiat money and keeping it.
• Donating the cryptocurrency possession to an authentic tax-spared charity or non-profit organization.
• Receiving a gift(until you sell or are involved in any other transactional activities with it)
• Giving a gift( you can gift $18,000 per recipient in 2024. If you exceed the limit, you may have to file a gift tax return).
• Transferring cryptocurrency to a different account owned by you. 

How to report crypto income on taxes?

To report your cryptocurrency transactions and activity, you need to use Form 1040 Schedule D as your primary crypto tax form. Your total capital gains and losses should be recorded in this form. Taxpayers need to use other tax forms like 1099-NEC or 1099-MISC. The form usage will vary according to your cryptocurrency activities.

To report the losses and gains from crypto transactions you need Form 8949. The name of the cryptocurrency, the specific date you acquired it, sold, traded, or disposed date of the cryptocurrency, the sales price of the currency, cost basis, and total gain or loss are the required pieces of information that need to be filled on form 8949. 

Users can accumulate all the details from the crypto exchange because they will keep the entire transaction history. It can ease the process and help you to do proper documentation. There is crypto software available to calculate and analyze the gains or losses.

There are some exceptions regarding the cryptocurrency tax. The transactions are not taxable if it is invested through tax-deferred accounts like IRAs and Roth IRAs 

Strategies to reduce Crypto tax liability

Crypto tax liability is the amount of taxes owed on cryptocurrencies-related activities and transactions. There are mainly three types of cryptocurrency liability in the tax system. Capital gains tax, income tax, and value-added tax are the three types.

• Capital Gains tax: tax on the profits from cryptocurrency-related transactions like selling, exchanging, trading, etc.
• Income Tax: it is a type of cryptocurrency tax, that is meant for cryptocurrencies that are earned via mining, staking, and receiving as payment. 
• Value-added tax: it is the tax on goods and services purchased with cryptocurrencies.

We can adopt different kinds of strategies to reduce tax liability. The important strategies are:

• Tax loss harvesting: Tax loss harvesting is offsetting capital gains with losses by selling cryptocurrencies that are not performing well in the market. 
• Holding period: Holding cryptocurrency assets for over a year can benefit you from lower long-term capital gains taxes.
• Donations: Donating cryptocurrencies can result in tax deductions with the avoidance of capital gains taxes
• Crypto IRAs: Some investors prefer to hold their cryptocurrency in self-directed IRAs to defer and eliminate taxes or gains.  
• Stablecoins: Converting your cryptocurrencies into stablecoins rather than cashing out would be ideal. This could avoid particular taxable events.

The above-mentioned strategies will always depend on the user’s region. It can vary according to the country’s policy and tax system. 

Future of Cryptocurrency Taxation

The cryptocurrency arena is a growing sphere with more advanced blockchain technology integration. It is a decentralized transaction system, so proper governance is still unattainable until the users are willing to disclose their possessions and transaction details to the IRS. 

As the cryptocurrency sphere grows, tax laws will also evolve, since governments are treating cryptocurrencies, every tax law applied to the properties will most likely continue in the cryptocurrency system as well. Governments and authorities are pushing for more transparency in cryptocurrency transactions. According to the latest pieces of information, several governments have already planned to implement systems to measure and monitor taxable crypto transactions and events.

What happens if you don’t report crypto taxes?

Failing to meet the requirements for reporting crypto taxes can cause a lot of financial and legal complexities and consequences. The IRS and tax authorities can impose penalties for not reporting taxable income. Users who fail to deliver the cryptocurrency transaction details or report the income could be subject to the failure-to-file penalty. The percentage of penalty can start from 5% and can lead up to 25% when the issue worsens or the user fails to meet the requirements instructed by the authority.

Other penalties are failing to pay penalty (0.5% of unpaid taxes for each month and this can go up to25%), accuracy penalty(it can go up to 20% of any unpaid tax) civil fraud penalty(this will go up to 75% of the underpaid tax), etc. Apart from this IRS can fine the nonpayers by implementing interest on unpaid taxes. A quarterly interest system is the adopted method here. Failure to deliver the appropriate data on cryptocurrency transactions and tax details will lead to IRS audits and investigations.

Conclusion

Cryptocurrency taxation is a growing process in the financial system. Governments are bringing the cryptocurrency under the tax payable item and consider it as property. So any transaction with it is subject to tax payment. Tax authorities are experimenting and implementing the latest methods to track the transaction data and cryptocurrency possession of individuals.

Failing to report cryptocurrency transactions and their inaccuracy will lead to legal and financial punishment. Authorities can charge penalties, interest, and audits. And even criminal charges for the tax evasion. 

Those who are interested in cryptocurrency projects and wish to earn money via their transactions need to know the basics of cryptocurrency taxation. Equipping yourselves with adequate pieces of information can only ensure you the safest cryptocurrency trade and transaction. So follow the regulations put forward by the authority and enjoy the crypto journey.