Things can be quite intimidating when we talk about the world of cryptocurrency, so before we go further about your crypto tax obligations, you must first learn these:
What is Virtual Currency?
Virtual currency functions as a medium of exchange or transaction that is only available in electronic type. It is a digital representation of monetary value that is stored and transacted through applications, digital wallets or software over the internet or some networks.
Virtual currency is a sub-cluster of digital currency types that includes cryptocurrencies.
There is also a thing called “convertible virtual currency” that has an equivalent value to the real economic currency. Bitcoin for one is an example of a convertible virtual currency that has a designated equivalent value to the fiat currencies (e.g Euros, Peso, US dollars, etc.) and can be electronically traded between buyers and sellers for products or services.
Investing in Cryptocurrency
While the main goal of investing is gaining profit by buying assets that might help you expand your shares, stocks or property values, investing in cryptocurrencies appears to be more complex than the knowledge we know about capital gain or deduction.
Cryptocurrency became a mainstream that the International Revenue Service (IRS) addressed and intervened in the taxation of its transactions.
The IRS has issued guidance to the process of taxation in cryptocurrency transactions which is called the Notice 2014-21 that states, cryptocurrency is treated as a property for federal tax purposes.
“The general tax principles must be applied to all cryptocurrency transactions and trades.”
The virtual currency, including cryptocurrency, is one of the ongoing focus zones of the International Revenue Service (IRS) Criminal Investigation. Through their Virtual Currency
Compliance campaign, they can investigate potential criminal tax violators through an examination process of taxpayers. This is to address the noncompliance of tax principles concerning the use of virtual currency transactions.
Cryptocurrency investors who do not make proper reports of their income taxes have to face consequences of virtual currency transactions that will undergo an auditing process for each transaction they made. When found guilty of noncompliance and violation, they can be held liable for interest and penalties.
For extreme cases, like any other type of tax fraud, if you violate tax principles it can result in a maximum fine of $250,000 or five years imprisonment.
Types of Cryptocurrency Taxes
Long Term - means that you held cryptocurrencies for more than a year before selling or trading.
Short term - applies to cryptocurrencies you held for a span of less than a year before selling and trading.
Virtual Transactions Bring Real Tax Implications
Trading in Cryptocurrency
Selling in Cryptocurrency- This can be considered as a gain or deduction to your capital. For example, when you sold your bitcoins, the gain is considered as an investment income which means you owe tax to the government. On the other hand, if you sold bitcoins at a loss, it is called a capital loss and you are entitled to a deduction.
(* Note that if the bitcoins you are planning to sell are held for a span of less than a year before selling or trading, a short-term capital gains tax is applied, which has an equivalent value to the income tax rate for individuals. However, if the bitcoins you are trying to sell are held for a year or more than a year, long-term capital gains tax rate is applied)
Buying in Cryptocurrency - In a situation where you buy products or avail services in cryptocurrency, you do not need to report this transaction with the International Revenue Service (IRS). For example, when you buy a share from a company with the use of bitcoins, you do not owe bitcoin taxes to the government for this kind of transaction.
Donating in Cryptocurrency
Donating cryptocurrency directly to a charity is a kind of approach that provides significant benefits to you. It entitles you to a cryptocurrency tax deduction that is equal to the fair market value of the donated cryptocurrency. Donors will not pay taxe. The charity you chose will receive the full advantages and value of your donation. In this kind of approach, your donation (e.g bitcoins) must have been held for a year or longer than a year.
If you are cryptocurrency miners, all of your mined cryptocurrency coins are counted by the IRS as taxable income. The mined coins are included in the gross income and taxed based on the fair market value of the coins at the time they are mined.
Tax Implications for Airdrops
The IRS does not dispense any guidance to determine the fair market value of airdropped tokens. Airdropped tokens are potentially an income realization event to the receiver. However, it is uncertain when the income will eventually be recognized as taxable income.
Cryptocurrency’s Blockchain Forks
A blockchain fork is a collectively agreed upon software update. If a Blockchain core developer updates cryptocurrency (e.g Bitcoin, Ethereum, Litecoin, etc.) codes to install and upgrade necessary features and significant parameters that are used in blockchain's active systems, the software’s update may or may not be compatible with the older version of the software.
Hard forks happen when there is an incompatibility between the updated software and the older version of the software. This type of update is more on the mining algorithm, block sizes and consensus protocols of the blockchain.
Soft forks are updated software that still works or still compatible with the older versions.
Right now, the IRS has yet to release guidance on the hard fork transactions, CPAs and tax experts even cryptocurrency coin traders are debating on what tax treatment should be given to these certain blockchain forks.
Cryptocurrency has a long way to go and probably will continuously grow. As time passes by, more and more are engaging in cryptocurrency investments. It is critically important for taxpayers to stay alert of any updates and be vigilant for any clarity from the International Revenue Service to the things that are currently still unclear and uncertain.