It is not uncommon for people to invest in cryptocurrency like they would in stocks. Cryptocurrency is a means of exchanging goods and services. Decentralization is one of its key benefits, as it removes the need for banks, financial institutions, and other central authorities to operate.
Cryptocurrency is also secure. Transactions are encrypted with specialized computer code and recorded on a blockchain — a public, digital ledger in which every new entry must be reviewed and approved by all network members.
Cryptocurrencies are growing more and more popular, but many people are still uncertain about how to treat them for tax purposes. For small firms, it can be tough to figure out how to handle taxes when it comes to crypto transactions.
We've put together this short guide on crypto tax considerations for small businesses to help you stay compliant with the law and make the most of your virtual currency transactions.
Whether you are just starting with cryptocurrencies or have used them for a while, it is crucial to learn how to record and file your taxes correctly. With the correct information and tools, you can efficiently manage your crypto tax requirements and take full advantage of all the perks of employing bitcoin in your business.
As crypto continues to gain traction worldwide, more small businesses in the U.S. accept cryptocurrency from clients as a payment method for goods or services. Some even use it to cover their company's expenditures.
Suppose your small business has started accepting or is considering accepting cryptocurrency as payment. In that case, it is crucial to understand the potential business and tax ramifications that come with the receipt of this type of money.
What Are The Tax Ramifications Of Accepting Cryptocurrencies As Payment For Products Or Services?
In the view of federal income tax authorities, bitcoin received as revenue in doing business is not considered the same as ordinary income taxes. According to the Internal Revenue Service, cryptocurrency is not truly considered legal tender. Rather, it is considered property.
When firms accept cryptocurrency as payment for goods or services, the fair market value of the crypto payments received is ordinary income subject to taxable income, including self-employment tax. You can read more about how to accept crypto payments as a business here.
A business owner who receives and keeps cryptocurrency in a digital currency wallet to pay for business expenses can claim another taxable event. Some opt to convert cryptocurrency to cash later rather than right away- to use it to pay for their business expenses later.
You will need to determine whether the cryptocurrency appreciated (went up) or depreciated (went down). That is because you will owe taxes on the amount of the increase.
If you had your cryptocurrency for less than a year before trading it or using it to make payments, you must disclose short-term capital gains or losses.
Long-term capital gains tax rules and reduced capital gains tax apply if the holding period exceeds one year. Fortunately, you can deduct cryptocurrency capital losses of up to $3,000 against other realized capital gains, just like traditional assets.
You owe capital gains taxes on the earnings if you profit from trading or utilizing it. If you accept payment for it or earned income, you are liable for income taxes on the earnings. Nonetheless, the cryptocurrency world is becoming increasingly complicated, even for officials who devote their careers.
When Should You Include Cryptocurrency Transactions in Your Tax Return?
Yes, your crypto is taxable. Here is when you report cryptocurrency to the Internal Revenue Service (IRS):
Purchasing Cryptocurrencies Using Dollars
Simply buying virtual currency in U.S. dollars and storing it on the exchange or transferring it to your wallet does not mean you will owe taxes at the end of the year. If your sole crypto-related action this year was the purchase of a virtual currency using U.S. dollars, you are not required to declare it to the IRS, according to IRS instructions included with your Form 1040 tax return.
Certain transactions become taxed when you utilize cryptocurrency as a medium of exchange. The process includes:
- Swapping your cryptocurrency for U.S. dollars.
- Exchanging one cryptocurrency for another—for example.
- Purchasing Ethereum with Bitcoin—or using Bitcoin to pay for products and services.
Trading or minting non-fiduciary tokens
A non-fungible token, or NFT is a digital asset developed on a blockchain that demonstrates you are the sole owner of that one-of-a-kind thing, whether it's a digital sports collectible or an animated flying cat with a Pop-Tart body. And, like cryptocurrency, they are subject to taxation.
However, because the IRS has not issued detailed tax guidance on NFTs, navigating the system can be tricky. Tax consequences of NFTs depend on whether you invest in it or create it and whether you do it for business or pleasure.
If you are generating or minting non-fungible tokens, it is critical to understand which events are taxable and how they are taxed.
Paying petrol fees to mint an NFT, for example, is a taxable event. Another taxable event occurs once you sell the NFT for cryptocurrency or exchange it for another NFT. It would count as revenue because you are gaining (or losing) money from the sale of the NFT you generated. Royalties earned on an NFT you generate are also taxable as income.
Taxes work similarly for NFT investors as they do for cryptocurrency traders. Most art-based NFTs are categorized as collectibles for tax reasons, making them liable to capital gains taxes, much like other popular cryptocurrencies.
Capital gains taxes will apply if you purchase an NFT with a cryptocurrency or sell an NFT. The amount you owe will vary by the time you owned the NFT and whether you profited.
When I Own Cryptocurrency, How Do I Prepare For Tax Season?
Prepare for tax season early by organizing your crypto taxes. Virtual currency transactions appear on the standard Form 1040 tax return. Take note of the following if you answered yes:
Keep Records of All Transactions
You must keep track of all your cryptocurrency transactions, including how much you paid for crypto, how long you held it, how much you sold it, and receipts for each transaction.
By transferring coins between your account and cold wallets, your crypto exchange might not record the cost basis for your crypto on a 1099-B.
The use of blockchain will enable software companies to detect transactions between your wallets, whether they are on an exchange or not, and provide you with reports of all transactions related to the wallets you give them within the tax year.
Tools connect to exchanges and crypto wallets to track your crypto transactions and complete the forms you need to file your cryptocurrency taxes.
Fill Out the Proper Tax Forms
Following your crypto transaction record, you will have to fill out certain tax forms based on how you used your crypto:
- Form 8949. The form logs every crypto investment transaction: purchase and sale. Be sure to track how many coins you bought or sold per transaction and whether you made or lost money.
- Schedule D. This form summarizes your capital gains and losses, including cryptocurrency investments.
- Schedule C. Mining coins are taxable, and you must disclose whether you received them for a business or a hobby. When running a crypto mining business, you may owe self-employment taxes if your income outweighs your expenses.
- Schedule 1. Reporting your crypto mining income as a hobby is on line 8 of Schedule 1. You don't owe self-employment tax; however, your deductions for expenses are limited.
File Your Taxes
If you keep records in software, you can connect them with your online tax software. Use the online tax software to file state and federal tax returns.
Hire a Tax Professional
Tax preparation for cryptocurrency can be challenging due to their laws constantly evolving. For cryptocurrency investors who make a lot of money, a certified public accountant (CPA) who specializes in tax work may be able to help you avoid IRS hassles.
Along with helping you prepare for another tax year, a tax professional provides legal advice on tax implications and capital assets and guides you on how to avoid money laundering.
Common Issues That A Financial Advisor Will Help You With:
- Reporting capital gains and losses correctly
- Coin-to-currency trades
- Coin-to-coin trades
- Coin hard forks
- Deducting coin-trading costs
- Purchasing goods or services with coins
How to Calculate Crypto Capital Gains?
You can divide gains and losses in capital assets into two categories: long-term and short-term. You'll come across very different tax consequences depending on how the IRS treats these two classes.
- Capital gains and losses from short-term capital sales result from selling properties you held for one year or less. These gains will cost tax as ordinary income between 10% and 37% in 2021.
- Profits and losses from long-term capital gains are from the sale of assets you held for more than one year and are subject to tax at preferential long-term capital gains rates of 0%, 15%, or 20% for 2021.
Property cost basis is the first thing you need to determine if you made a profit or loss. As a general guideline, this is the price you paid, minus any fees and commissions you paid to engage in the transaction. Essentially, this is known as an 'adjusted cost basis.'
Once you have determined the sale amount, you adjust or reduce it according to any fees or commissions you paid for the transaction.
Finally, you subtract your adjusted cost basis from the adjusted sale amount to determine the difference, resulting in either an increase or decrease in your capital gains, depending on whether your adjusted cost basis exceeds the adjusted sale amount.
Use a Crypto Tax Calculator to figure out how much tax you will have to pay on your capital gains and losses from crypto activities using a Crypto Tax Calculator.
Are There Taxes On Cryptocurrency That Have Been Lost or Stolen?
In general, you cannot deduct losses from your tax return for crypto that has been lost or stolen. According to the IRS, capital asset losses fall into casualty and theft losses.
In general, casualty losses in the crypto realm refer to your crypto's damage, destruction, or loss due to an identified, sudden, unexpected, or uncommon incident. For instance, this may include unintentionally sending your cryptocurrency to the wrong wallet or another similar event.
However, additional aspects may need consideration to decide whether the loss qualifies as a casualty loss. When your wallet or crypto exchange is compromised, theft can occur.
In either instance, capital losses are not eligible to offset your winnings. Due to tax reform legislation in 2018, casualty and theft losses are not deductible between 2018 and 2025. Taxpayers can claim this deduction in the future if they itemize their deductions rather than claim the standard deduction.
How Can I Avoid Or Reduce Paying Cryptocurrency Taxes?
You may be able to make tax-free cryptocurrency transactions in some circumstances, depending on the transaction, the account used, your income, and filing status. There is no taxable event when you purchase cryptocurrencies, even if their dollar value increases. Purchasing and holding a cryptocurrency has no tax implications unless you decide to sell or trade it.
Cryptocurrency transactions made in a tax-deferred or tax-free account, such as a traditional or Roth IRA, are not taxed as they would be in a brokerage account. These transactions are tax-exempt. Those with overall taxable income under $80,800 or a total table income of $43,400 do not owe capital gains taxes on long-term cryptocurrency sales.
If you believe you may be liable for crypto taxes in the future, here are six strategies for minimizing them:
Long-Term Investing in Cryptocurrency
If you hold a cryptocurrency investment before selling it for at least a year, your gains are eligible for the long-term capital gains tax. If you have taxable income for the year, you may be able to reduce tax rates by nearly half, from a maximum of 37% on short-term capital gains to just 20% on long-term gains.
Net Gains and Losses
For any investment you make, cryptocurrency gains are deductible by deducting losses from other investments you made when you realized your profit. If you earned $10,000 from Bitcoin but lost $10,000 from Ethereum, you would owe no tax because you broke even.
However, these losses are not limited to other cryptocurrencies. Review the rest of your portfolio to offset losses if you plan to liquidate a large cryptocurrency holding. Additionally, suppose you lose much more money than you earn in a given year. If you have any excess losses on this investment, you can deduct up to $3,000 from your income taxes, and you can carry any unused losses forward for future investment gains.
Adjust Sales to Account For Your Tax Rate
Suppose you have the luxury of time on your side. In that case, you can always wait for lower tax rates. Perhaps you were laid off, retired, returned to school, or relocated to a state with a lower tax rate. Then you may find yourself in a reduced tax band, allowing you to sell your cryptocurrency while still owing less in taxes.
Claim Mine Expenses
While mining cryptocurrency may appear to be a low-cost activity, in theory, it incurs high costs, such as computer equipment, electricity, and ISP fees. Cryptocurrency miners can deduct these costs from your mining income. The amount you can deduct will vary depending on whether your operation counts as a business or a hobby.
Consider Investing In A Retirement Plan
Suppose you invest in cryptocurrency through a retirement plan such as a standard IRA or Roth IRA. In that case, you can defer or eliminate investment profits, albeit this is not as simple as investing through a traditional brokerage account. To open a crypto or Bitcoin IRA at the moment, you must create a self-directed IRA account with a boutique firm that specializes in crypto investing.
Donate To Charities
Taking advantage of your tax exemption means giving at least a portion of your cryptocurrency to charity, even if you don't expect to benefit from the investment fully. You'll be eligible for a tax deduction equal to the full amount of your cryptocurrency, including any gains. However, this makes sense only if you previously planned to donate to charity.
Understanding Taxes And Crytocurrency
Taxation of cryptocurrency is considerably more complicated, so you may want to seek the advice of a certified public accountant or an attorney regarding tax reporting and implications.
Over the next few years, tax policy and financial regulation around cryptocurrencies are certain to shift. Even the enormous infrastructure bill, which has remained in Congress since its introduction in late 2021, makes mention of bitcoin with suggested revisions to the reporting requirements for crypto exchanges.