A friend of mine who is an active crypto trader recently told me about his experience doing his personal crypto taxes. He’s a die-hard, anti-system kind of a guy, but he did everything to a tee. Because you never know what broke governments are willing to do.
After recording every single transaction, his supporting documents came out to more than 10,000 sheets. More sheets than the IRS will even allow you to submit. I have to say, that made me very glad to be in the HODL camp.
If you are a US citizen or resident, the hard truth is that you’re dealing with one of the most complex tax systems in the world by default.
But now, if you use crypto at all, it’s twice as complicated.
If you have engaged in any of the following activities, you have additional considerations to include in your annual accounting:
- Traded crypto in an exchange,
- Earned crypto from mining,
- Received crypto as a gift or inheritance,
- Used a foreign crypto exchange,
- Invested in or issued an ICO or STO.
That’s right, pretty much anything related to crypto. On top of that, as of this year, you now need to specifically declare whether or not you’ve made any crypto transactions on your tax forms.
Hopefully, by now, you’ve already enlisted professional help to prepare your taxes. But just in case, read on to learn the basics of crypto taxation for US citizens and residents. Including what you need to report, what you owe, and which forms you need to file for your crypto activities.
Obviously, each person’s tax situation is very unique. For this reason the information contained in this article is meant to act as a general guide that can help you better understand the tax implications of your crypto activity. Use this as a starting point to direct your own research and to inform yourself before speaking with a tax advisor.
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Crypto tax reporting
2020 UPDATE: New requirements to report crypto transactions on US tax forms
The biggest news in US crypto taxation this year is that for the first time, all US citizens and residents will have to report any crypto transactions on their annual tax forms.
Found on Form 1040’s Schedule 1 under “Additional Income and Adjustments to Income” is the following question:
“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
This is just a reporting item and does not necessarily make you liable for any taxation.
But, failing to report your holdings counts as tax fraud and can come with severe consequences.
According to the IRS instructions for the form, if you haven’t engaged in any virtual currency transactions during the tax year and otherwise don’t need to file, then it is not necessary for you to fill out this form just to answer this question. But if you are filling out this form for other purposes, you definitely do not want to skip this line.
How will the IRS ever know that you have crypto? Actually, it’s a lot easier than you think.
If you’ve traded more than $20,000 or made over 200 transactions on a crypto exchange, US regulators require the exchange to report your activity directly to them.
On top of that, thanks to public distributed ledgers and subpoenaed documents from crypto exchanges, it is very simple for tax authorities to trace every single transaction you’ve made.
The days of crypto exchange anonymity are over.
With heightened KYC AML and the rise of chain analysis companies it is easier than ever to connect wallets to the people behind them.
In summary, don’t think your activity is private. It’s not.
Choosing not to report your crypto transactions can land you with a variety of penalties. This includes criminal prosecution, five years in prison, and fines of up to $250,000.
If you have any crypto, just tick the box.
Foreign Account Reporting
Have you used a foreign exchange or foreign-based wallet in the last year? If so, chances are that you have a few more forms to fill out.
Here are a few examples of popular foreign crypto exchanges:
- Binance (Malta, Cayman Islands)
- Bitfinex (Hong Kong, China)
- BitPanda (Austria)
- Bitstamp (Luxembourg)
- CEX.io (UK)
- Huobi (South Korea)
- Jaxx (Canada)
- Kucoin (Singapore)
According to FBAR, the US’ Foreign Bank Account Reporting requirements, if you have held at least $10,000 in foreign accounts during the past year, you need to give the US Treasury a heads up using FinCen form 114, and the IRS with form 8938.
To do this properly you need to:
- Take the maximum amount that you’ve had in all of your foreign crypto accounts and foreign bank accounts during the past year. It doesn’t matter how much you had as of Dec 31st, they want to know the maximum during the year.
- Convert those amounts to USD. If a foreign currency, you can use the Treasury’s official exchange rates here. If crypto, then use the highest market price during the year. For Bitcoin, for example, the highest rate in 2019 was $12,575.90 according to Coinbase.
- Add up all your funds held abroad. If the total exceeds $10,000 you need to report each of your accounts on the two forms above. If the amount is below $10,000, then you do not need to report.
Note, this does not apply to offline, hard wallet holdings. It only applies when the institution directly holds private keys on your behalf. That said, if you’ve used a foreign exchange at any point for transactions of $10,000 or higher, it still counts. Even if you only kept the funds there a day or a few hours.
As a reminder, none of the requirements mentioned so far imply any kind of tax obligation. They are simply reporting requirements.
For the actual tax implications of your crypto activities, read on in the next section.
Crypto tax obligations
In this section, we discuss the tax implications of different crypto activities. We also discuss the tax rates for each category and the forms that all US citizens and residents must file. Enjoy!
Crypto tax requirements for transactions
In 2014, the IRS officially classified cryptocurrencies as ‘property’. Due to this classification, all cryptocurrency gains are subject to capital gains tax.
This may seem like a minor detail, but the implications are huge for anyone that trades or transacts with crypto. Because now, each and every transaction must be treated as a taxable event.
Given the speed and frequency of crypto trading, this can create a reporting nightmare for crypto traders.
Crypto investors and users must record everything from tiny transactions to large investments. This includes the date of each transaction and its value in US dollars. And yes, this includes the cup of coffee you bought with Bitcoin last September.
It’s a thankless and time-consuming task, not to mention intrusive.
Imagine if you had to report every single purchase you made with your credit card to the government each year. And then convert all of those purchase prices into a different currency. Not only at today’s price, but at the fair market value at the time of the purchase.
You would need to know the exact time of each transaction and price of the crypto at that precise moment! That’s the practical result of having crypto classified as ‘property.’
And it doesn’t stop there. Having recorded this data on a spreadsheet, you must then determine your capital gains or losses. You must make calculations within the parameters of short and long-term investments. And then report that all of that information in your tax return.
And that’s just for ‘normal’ transactions. If you are also invested in crypto projects check the sections below for further tax guidance.
To simplify your life, we’d recommend preparing your tax returns with a crypto tax software such as:
These allow you to export all of your transactions and make calculations based on your preferred accounting method. For example, First in First Out (FIFO) vs. Last in First Out (LIFO).
Given the differing capital gains tax rates for long-term vs. short-term holdings, these two methods can give you slightly different tax obligations. (Click here to view a comparison of the different tax rates.)
Report any income from crypto sales on Form 8949 and then summarize them on Form 1040 Schedule D.
Crypto tax requirements for investments
When it comes to crypto investments as opposed to crypto transactions, things get even trickier.
Imagine if you want to use crypto in lieu of fiat to make a loan. Let’s say you want to lend 100 Bitcoin at 10 percent interest. Theoretically, your transaction should result in a capital gain of 10 Bitcoin. Thus, you should be liable for taxation on that amount.
However, since you must record transactions in US dollars, all of the transactions must be converted to dollars at the time of the loan and repayment.
So, if the price of Bitcoin rises (or falls) during that time, that simple transaction could render you with a much higher (or lower) capital gains liability. This holds whether or not you ever realize a gain in dollars.
Applying archaic asset classification to this new asset class has created a significant disconnect between what’s happening on paper versus what’s happening in reality.
Nonetheless, it is imperative that you are aware of these requirements so that you can accurately report your capital gains earnings.
Again, report your capital gains on Form 8949 and then summarize them on Form 1040 Schedule D.
If you’ve earned more than $1,500 in taxable interest, be sure to also file your interest earnings on Form 1040 Schedule B.
Tax requirements for crypto earned as income (mining etc.)
What if you didn’t buy your crypto, but instead earned it through mining?
Any crypto gained through mining is taxed as ordinary income, based on the “fair market value” of the crypto on the date it was received.
Additionally, if you are mining for yourself, and not for an employer you are also subject to self-employment tax on your mining profits.
The self-employment tax rate for the 2019 tax year is 15.3 percent on your first $132,2900 of net income (revenues minus expenses and losses). It is 2.9 percent for everything you earn beyond that.
For this you will have to report your earnings on your Form 1040, U.S. Individual Tax Return, and Form 1040 Schedule SE.
Crypto as gifts or inheritance
Crypto received as a gift follows the standard rules of all major gifts.
Essentially, you are not liable for any taxes on the gift until you choose to sell it. Once you sell it, the capital gains liability will be based on the price at which it was purchased by the person who gifted it to you.
For the most part, the same applies to crypto received through an inheritance. Though in some cases you can apply to have the base value of the crypto adjusted to the fair market value on the date you received the inheritance.
Crypto tax rates
By now you should know how you will be taxed on your crypto tax earnings. Now the dreaded question: how much do I owe?
For crypto trading income, the answer to that depends on how long you’ve held your crypto before selling it. If you’ve held your crypto for less than a year before selling it or transacting with it, it’s considered a short-term capital gain.
This is taxed at the same rate as ordinary income, which according to your income bracket for 2019, can be anywhere from 10 to 37 percent.
But if you’ve held your crypto for more than a year before using it, your transactions can be subject to more favorable long-term capital gain tax rates. These vary from 0 to 20 percent, depending on your income bracket.
If you’re in the top three highest income brackets, you also have to pay a 3.8 percent tax on net investment income.
You can view the latest tax brackets and rates here.
US taxation of ICO/STO investments
While conventional cryptocurrencies like Bitcoin are treated as property for federal tax purposes, the treatment of initial coin offerings (ICOs) and security token offerings (STOs) isn’t so clear cut.
Since the IRS has not yet released an official tax statement on token sales, there is some general confusion on how ICOs and STOs should be taxed. However, just as the SEC tries to apply 80-year-old securities law to crypto, the IRS will also likely attempt to apply traditional tax law to the taxation of ICOs and STOs.
Crypto taxes for STO investors
In the case of STOs, it’s clear that the tokens are sold as part of a securities offering. As a result, these tokens can be classified in the same way as traditional securities.
If the STO represents equity, its tokens will be taxed like equity. If the STO represents debt, its tokens will be taxed like debt. The fact that the offering is handled through an STO as opposed to a traditional security offering does not garner it special tax treatment.
Crypto taxes for ICO investors
For most of 2018, the SEC had a clear stance that it considered all ICOs to be security token offerings.
But in early 2019, they shifted their position. First, the SEC chairman said that some ICOs may have initially been securities offerings, but over time they could become something else. This was followed soon after by a new SEC framework for digital asset “Investment Contracts”, which indicated that not all ICOs will be securities offerings.
This leaves purchasers of ICOs in a complicated situation. Are the tokens securities or property? And if they are securities, which type?
The SEC’s case-by-case treatment of individual ICOs and tokens will continue to make it a difficult and daunting task for those looking to stay on the good side of the IRS.
US taxation of ICO/STO projects
Another key area of debate is the tax liability projects face when they raise money via token offerings. Again, the distinction between whether the token offering qualifies as a security offering is critical.
Crypto taxes for STO Issuers
According to existing tax law, when a company engages in a security offering and raises capital, this is not considered taxable income under US accounting standards. With STOs, this means that issuers don’t face any tax liability from the initial sale of tokens. But when those tokens are bought or sold thereafter, traders are liable for taxes on the capital gains.
Crypto taxes for ICO Issuers
For ICOs, their tokens are considered ‘goods’. This means they do not qualify as securities offerings. As a result, issuers may be liable for income tax from the moment the initial sale of tokens takes place.
The distinction between token offerings
Not surprisingly, how a project handles its tax liability when launching a token offering, is becoming a significant matter of debate.
In late 2018, Kik, the Canadian instant messaging app, was notified by the SEC that its token offering was an unlawful securities offering.
Unwilling to back down, Kik responded with a comprehensive letter that outlined why it’s offering should not be considered a securities offering.
One of the many arguments Kik made in its defense was that it had paid taxes on its token offering, thus demonstrating that Kik did not treat its token offering like a securities offering.
If the tokens were securities, Kik would not have had to pay taxes. Essentially, if the SEC wins then the IRS loses and Kik should get a major tax refund. (Side note: Is it bad if I root for both the SEC and IRS to lose?)
Similarly, any projects trying to make the case that they did not hold an unlawful securities offering, should have declared income on their token offering and paid the subsequent income tax. For projects that raised $20M in an ICO, you might owe 35 percent (or ~$7M) in taxes.
If you think your token offering might be classified by the SEC as an unregistered securities offering, click here to learn what you need to do to minimize the penalties.
What does this mean for Crypto Law Insiders?
One of the biggest challenges facing crypto today is regulatory uncertainty. Unsure of the law and how it applies to their projects, many crypto entrepreneurs are hesitant to take action. After seeing other projects fined hundreds of thousands of dollars for being out of compliance, they are understandably nervous about making the same mistakes.
The bottom line is that making a good faith effort to be in compliance is 9/10ths of the battle.
I’ve spoken to many crypto traders who haven’t filed returns on their crypto taxes because they’re scared they will mess it up. But not filing tax returns is not the right approach and will leave you exposed to criminal penalties.
For Insiders, I recommend you instead do your best, act in good faith, let your CPA file the return, and keep your fingers crossed.
