Since at least 2014, it has been clear that bitcoin income would be taxed. In IRS Notice 2014-21.1, the IRS talked about the basics of how to tax bitcoin. In this notification, virtual currencies were put in the category of property instead of foreign money.
When used in a transaction, its value is based on its current market value in U.S. dollars. Capital gains tax is paid on the difference between what something was bought for and what it cost. If you sell or trade an asset for a profit, you have to pay the capital gains tax rate.
Taxes and cryptocurrencies: What you need to know
In 2019, the Internal Revenue Service (IRS) sent out about 10,000 letters to people it thought owed money to the government in taxes for exchanging virtual currency. No longer could cryptocurrency transactions be made without being seen.
The government agency likely made its list of beneficiaries by looking at customer data from the bitcoin exchange Coinbase. The IRS has warned that people who don’t record their income correctly could face fines, interest, or even criminal charges.
A Struggle for Openness
Bitcoin was set up in 2009 as a peer-to-peer money system. Because of this, it was made to be easy to use and easy to store. In the same way that you can’t find out what’s in a numbered Swiss bank account, you can’t find what was in your virtual wallet. Soon, governments saw a rise in money laundering using cryptocurrencies.
It was only a matter of time before tax authorities noticed that it was hard or impossible to tax money that couldn’t be seen. Most Bitcoin transactions are now open to the public. Cryptocurrency exchanges require their customers to follow anti-money laundering rules, so they don’t get in trouble with tax authorities and government agencies.
There are different opinions among regulators, central bankers, and federal courts about whether Bitcoin is money or a commodity. Everyone agrees that the money made from trading and investing should be taxed, no matter how they feel about it.
Buying a digital currency
Let’s say you bought Bitcoin at the beginning of 2019 for about $3,700. By the end of February 2022, that bitcoin could be bought or sold for $38,500. In 2022, you will use Bitcoin to buy a BMW X1. I can tell you for sure that these prices are correct. Bitcoin is always changing because that’s how it works.
But this transaction affects both parties’ taxes.
- The seller must report the sale as gross income depending on how much a Bitcoin was worth.
- Depending on the difference between what the buyer paid for the Bitcoin and what it was worth at the purchase, they may have to file a capital gains tax return for the transaction. There is an opportunity that things might get complicated here.
- If you buy bitcoin, you might have to pay any taxes. You can spend less than a whole bitcoin. One hundred millionth of a Bitcoin, or one satoshis, is equal to one hundred millionth of a satoshi. Each coin of the virtual currency Ether is worth 1 quintillion wei.
Even if you only spend a fraction of a Bitcoin on coffee, you will still have to pay the difference in taxes between when you bought the coffee and when you drank it.
Use of cryptocurrency at taxable events
Unlike stockbrokers, cryptocurrency brokers are not required to give their clients 1099 forms. Merchants must report all sales to the IRS, so they don’t get fined for not paying taxes.
Withdrawal of Cryptocurrency
Your taxable gains (or losses) from cryptocurrencies are treated the same as gains or losses from any other asset: capital gains or losses. Previously trading cryptocurrencies for fiat funds like U.S. dollars, a trader needs to know a few things. So, if you bought Bitcoin for $6,000 and then sold it for $8,000, you’ll owe the short-term capital gains tax on the $2,000 gain.
When you sell an asset you’ve had for less than a year, the money you make is taxed as if it were deserved income. For the 2021 tax year, this could be anywhere from 0% to 37% of the taxpayer’s income. Long-term capital gains taxes must be paid if the same transaction takes place more than a year after the Bitcoin was bought. 0%, 15%, or 20% of your total taxable income for 2021, depending on how much you made.
The process of “mining” digital currencies
The commands are a little bit more complicated for people who mine bitcoin. Miners verify bitcoin transactions and add them to a blockchain public ledger. People take paid for the work they perform. Their pay is counted as company income for tax purposes, so they also have to pay income tax. They can also deduct the costs of their mining activities on their tax returns, like computer equipment and electricity.
Using cryptocurrency for personal purchases
If you trade cryptocurrencies often and use them to buy goods and services, keeping track of the taxes you owe on these transactions could be hard. Find out which coin was used to buy the coffee and write down its value and base value at the time. This method can only help with transactions that involve coins that have already been sold.
As long as the trader doesn’t use all of the Bitcoin they purchased for $8,000 to purchase a pair of pants, the trade won’t be seen as a loss. The smallest unit of money in the Bitcoin ecosystem is the satoshi, which equals one hundred millionths of a Bitcoin. One hundred thousand satoshis are equal to one millibitcoin. Another method to say this is that one satoshi equals one microbitcoin.
Buying and Selling Virtual Currency
If the investors trade one cryptocurrency for another, they must pay taxes on both. When you buy Ethereum with Bitcoin, it’s like selling Bitcoin, so you’ll have to pay taxes on the variance in value between when you got Bitcoin and when you spent it on Ethereum.
Keep track of your tax obligations for crypto.
Cryptocurrency exchanges make it easy for traders to keep track of all their transactions by letting them export all trading data for free. If the trader has a tax expert, this information could help that person figure out how much tax they owe. As you can perceive from the example above, blockchain-based solutions platforms can be used to record and highlight this information for tax purposes.
Wealth management platforms like TrustVerse use smart contracts to ensure that their users take care of tax and estate obligations correctly. It’s a best practice to talk to a licensed CPA before filing your first bitcoin tax return. Accountants and tax experts are learning more and more about how to handle cryptocurrency holdings.
As a stopgap, the Internal Revenue Service (IRS) has made a tutorial for updating old tax returns that briefly mentions Bitcoin and other cryptocurrencies. Traders with foresight are making plans for the crypto market next year, despite a lot of uncertainty.
Government policies and cryptocurrency
The relationship between cryptocurrency and the government of the United States is complicated. The government would probably be worried if many people used a currency. First of all, there are worries among government officials about giving a computer program control over monetary and fiscal policy.
And let’s not forget that the cryptocurrency markets are very volatile and have ties to illegal financial transactions and funding for the black market. But as time goes on, the way the partnership works changes. The government is okay with Bitcoin slowly becoming a big part of traditional financial services.
The cryptocurrency industry’s exchanges have begun to pair cryptocurrencies such as bitcoin with fiat currencies such as the U.S. dollar. The growing importance of Bitcoin in finance is demonstrated by trading Bitcoin futures contracts on significant institutional exchanges like the Chicago Mercantile Market and the Chicago Board Options Exchange.