Please note: The following information is for the US tax system. However, Accounting also provides complete crypto tax services for other countries including the UK, Germany, Australia, Switzerland, and Austria, and is fully compliant with the tax agencies in those countries.
This is essential to calculating profit and loss. The value of the cryptocurrency, both on the day of acquisition and the day it was used to get a service/product or exchanged for money or other cryptocurrencies, is to be recorded.
The next step is to determine if the crypto activity falls under any of the taxable events discussed in the earlier section.
Using the value computed in Step 1, the tax liability can be calculated. For instance, if cryptocurrency was purchased for $1000 and utilized/sold when the market value was $800, then it means there is a loss of $200. (Fair market value - Tax Basis= Profit/Loss)
Any loss incurred on cryptocurrency dealing can be used for offsetting capital gains. Losses that do not apply to offset capital gains are deductible from other kinds of income. This has a fixed limit of $3000. There are provisions to carry forward losses as well.
Form 1040, Schedule D is where income coming from Bitcoin and other cryptocurrency dealings is reported. Based on the nature of the transaction, the type of income that is made from cryptocurrency can vary- capital gain or ordinary income. It must be reported in the appropriate columns of the form. IRS Form 8949-D, used for reporting the disposal and sale of capital assets, is where all details of cryptocurrency transactions are to be filled.
After gathering the relevant data to generate a tax report, the next step is to file the tax report.
Once the tax basis and liabilities have been assessed, using the above steps, filing the taxes is the next step. For this, there is, also, a simple 5-step process to be followed, which is highlighted below.
The first step is to evaluate cryptocurrencies held with the market values on the day of acquisition and redemption. These details go under Schedule D of Form 1040.
Analyzing a cryptocurrency portfolio is easy, if assets are only in one crypto, like Bitcoin or Ethereum . However, if the portfolio is across multiple cryptocurrencies then the first step is to be done for each one. Most cryptocurrency exchanges have sufficient capabilities for portfolio analysis and reporting. There are many portfolio management products explicitly designed for cryptocurrencies.
With all the raw data in place, the next part involves organizing the different transactions. A few other points in addition to what has already been covered about taxable events are below:
Donations, in cryptocurrencies, to eligible charities qualify for tax exemptions.
After classifying transactions and evaluating capital gains, assessing taxes and ensuring compliance is key to creating a tax strategy. The 3 things to remember here are:
For-profits, it is always better to convert the cryptocurrency to dollars rather than another cryptocurrency. Taxes will be levied either way, so it is better to have some real currency to pay taxes on. However, this can differ depending on the total income, risk level, and goal with cryptocurrency investment.
Once all cryptocurrency data is stored and analyzed the tax report can be generated. Reviewing the report will help find other ways for saving taxes. For instance, holding cryptocurrency for over a year attracts capital gain tax, which can vary from 0% to 20% as per the tax bracket. On the other hand, cryptocurrency held for less than a year attracts tax around a 40% rate.
The American tax system relies primarily on a compliance system that is voluntary. Therefore, the IRS expects citizens to report all of their taxable transactions. A failure to do so can attract heavy penalties and even criminal prosecution.
The good news is that taxpayers can amend past tax returns and include cryptocurrency taxes.
There are a few ways in which the IRS can determine if one has taxable cryptocurrency transactions or not. For instance, if after a crypto exchange the taxpayer receives a Form 1099-B or Form 1099-K, then the 'matching mechanism' in the IRS Information Reporting Program will highlight this. Also, if the crypto exchange receives a subpoena from the IRS then they may be required to disclose user account details. Therefore, if one has exchanges, spent, or sold cryptocurrency in the past, then it is important to report them as crypto tax for that year without fail.
The IRS allows taxpayers up to three years to claim any refunds or losses. While most IRS audits take the past three years into consideration, some can go even further back. In case a taxpayer has not reported past years' crypto transactions in the tax filing, then this can be done in the following manner,
Step 1 - First they need to calculate how much is owed in crypto taxes in terms of capital gains. Tax preparation software platforms like TaxAct or TurboTax can be used to arrive at accurate calculation and manage amended tax.
Step 2 - The next step is to amend one's tax return after calculating the overall capital gains liability. This amendment can be done using the IRS Form 1040X. It is a self-explanatory form and requires only information that is updated or new.
Step 3 - Once the form is completed the taxpayer mails this form to the IRS as the amended tax return. It is essential to attach all the required supporting documents to make sure that the form is complete in every aspect.
In the case the amended tax liability is a higher amount, then one must include the additional payment while sending across the amendment to the IRS. Also, it is important to know the Fair Market Value of all trade transactions for retrieving capital gains or losses. While this may not be an issue in case the transaction volume is low but can soon become an issue in case of large volumes. Therefore, it is recommended to file for crypto taxes in the same financial year.
While tokens purchased using fiat currency are not considered as taxable transactions, any tokens purchased using a different cryptocurrency like Ethereum or Bitcoin, for example, will attract income tax. Token purchasers in an ICO ( Initial Coin Offering) typically conduct the purchase to hold the investment on the asset with the hope that it will appreciate in value. This taxable amount is calculated as the difference between the tax basis in exchange cryptocurrency and the value of the tokens that are purchased. Not much clarity is provided on transactions before 2018, however, after January 1, 2018, exchanging one type of cryptocurrency for another will attract tax.
For taxation purposes, if a token is used to pay a fee for using a blockchain platform or is used as a form of currency for exchanging property or services on such a platform, then such a transaction of tokens will attract tax implications.
If the token issuer is providing a service that can't be assessed unless the previously issued tokens are used, then the issuer's income will be considered as income equal to the fair market value of tokens at such a time when they are used.
Calculating and paying taxes can often seem like a tedious task, however, it is essential to incorporate all cryptocurrency transactions while filing annual tax returns. Even though it may seem that crypto transactions have an extremely decentralized and anonymous nature and the IRS may not have clear visibility on all cryptocurrency transactions to know whether the traders are generating revenues or not, this is certainly not the case.
There are enough and more software products in the market to help traders in the crypto tax filing process. These can be easily employed to ensure that one remains on the right side of the annual tax filing regime.
This guide should serve as a starting point in evaluating tax liability and paying taxes only on actual profits. Crypto-assets are likely to grow in the coming years- following the IRS's evolution on the matter will keep the US taxpayer on the right side of the law while earning profits.
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