Cryptocurrency and Your Taxes
2021 has been the year of cryptocurrency, in terms of news as well as new holders. More businesses are accepting various coins for transactions, and this is expected to increase through the rest of 2021 and beyond as sites such as Coinbase make them an easy payment option.
One often overlooked aspect of jumping into the cryptocurrency market is the tax implication. The tax code surrounding crypto seems as fluid as crypto pricing. There are some rulings on the books, and more are expected before the end of the year. Below are the key things to keep in mind and to keep track of so you do not find yourself surprised or worse, in trouble with the IRS.
The most important aspect of dealing with taxes and cryptocurrency is keeping accurate records. Taxation in all cases is based on the fair market value of the coin at the time of the transaction.
Depending on how you use your crypto, gains may be taxed as capital gains or income.
The IRS views virtual currency as property. This makes it subject to capital gains/losses rules. It is easiest to think of it as if it is a stock in the case of capital gains.
When you purchase the cryptocurrency, record both the amount you paid and any fees or commissions you paid to the seller (a platform like Coinbase for example). You do not have to report the purchase on your taxes, just as you do not have to report a purchase of a stock on your taxes.
If you have held it for over a year, it is taxed at the “long-term capital gains” rate, if you held for less than a year it is taxed at the “short-term capital gains” rate. Your holding period starts the day after you make your cryptocurrency purchase.
If you experience a loss, you may be able to offset capital gains tax and, in some cases, deduct up to $3,000 off your ordinary income. There are restrictions to this.
If you receive cryptocurrency through any of the following means, it is reported as ordinary income. The amount you record is the fair market value of the coin at the time of acquisition.
- Payment for goods or services
- Crypto mining
- Receive crypto from an airdrop
- Gain crypto as interest on DeFi lending
- Gain crypto through staking or liquidity pools
Many businesses are beginning to accept cryptocurrency for payment. Under present IRS guidelines, payment for goods and services in “virtual currency”, i.e., crypto, is taxed the same as payment with fiat currency.
The tax is calculated based on the fair market value of the coin at the time of payment. Therefore, if you do not exchange the cryptocurrency immediately and it the value goes up, you still pay tax on the amount it was worth at the time of transaction. If you then cash out at the higher rate, that profit is taxed as capital gains, not business revenue. The same applies if it loses value before cashing out.
If you pay your employees or contractors in cryptocurrency, you report that based on the fair market value at the time of payment and record the US dollar amount on their W-2 or 1099. You will have to report any gains or losses made on the transaction as a capital gain or loss.
You bought Dogecoin at $0.10
You paid a contractor in Dogecoin for a $100 job.
Dogecoin was worth $0.50 at the time of the transaction with the contractor.
You put $100 on the contractor’s 1099
You paid the contractor 200 Dogecoin ($0.50 x 200 = $100)
When you bought the 200 Dogecoin, it cost you $20, so you had a capital gain of $80. *
*For this simplified example, commissions and fees were not included.