By Larry Wright
Cryptocurrencies and the idea of decentralization have become somewhat of a sensation in the past decade or so. People have come around from all backgrounds and opinions about cryptocurrencies and decentralization and have balanced themselves into the marvelous and the most extensive use case of crypto in the history of finance. There were banks, enterprises, and people who negated the very idea of decentralization and presumed that it would be the end of modern finance, but now they have gathered on a single platform to cherish an immaculate and most outstanding adoption in the history of the financial world.
People are trading in cryptocurrencies, making money, investing in non-fungible tokens, and various other use cases such as decentralized finance protocols that cater to their very business interests and services are invested in. But with all of that, there comes the duty of paying the tax because at the very beginning crypto industry was an extremely unregulated space in terms of taxation. But that has drastically changed because many countries have prepared and launched their own taxation policies and regulations, which are now active on multiple cryptocurrencies for many decentralized finance platforms and even on mining.
Not so long ago, cryptocurrency was considered a niche that could only tempt the tech-savvy people, but now it is in the hands of everyone who is interested in making a quick buck and turning a handsome profit by simply investing their money into these upstream moving assets. Those were the days when the idea of putting the tax on crypto and or making a trade-in was not very clear, but now there are rules catered with respect to the country and or state people are interacting with cryptocurrencies.
It doesn’t matter whether you are just starting with crypto trading or have been doing it for some time; you have to report your income and pay taxes that apply to the particular profit which you have earned with crypto trading. Basically, your local tax regulations would determine how much tax is applicable to your winnings, and then you have to comply with it. It is also essential to note that if you have encountered or interacted with the crypto market in any capacity, then it is only wise to have a record of each and every transaction so that a proper tax information audit can be performed.
Is it Necessary to File Crypto Taxes?
There are people out there who try their best to avoid any and all taxes they have to pay on their income, and some even get away with it if the country or state they are currently living in has some kind of loopholes in its taxation system. You might also have the same proposal in mind why should you pay taxes on something that is so recent and have not even established a proper base, should you be paying taxes on your crypto earnings?
In the early days, cryptocurrencies were used to do and perform all sorts of illicit transactions and to hide money and even launder finances from one place to another, it was seen as a financial gray area, but those days are done. Today blockchain technology has reached a point where it is more sophisticated than it is strict, it allows people and organizations to take control of their finances into their own hands, but at the same time, they are not given the liberty to cheat the system or tamper with the transactions made.
But the system of taxes is completely tethered from that of decentralized working of the crypto market. When you are performing a transaction on a dedicated blockchain for a particular cryptocurrency, you have to pay a certain amount of fee, and after that, you are free to leave, get on with the transaction at hand, or perform some other.
As soon as you pay the fee that you owe to the blockchain environment, there is nothing else for you to pay because there is no concept of taxes in a blockchain or decentralized environment; this is another trademark of the decentralized world that is known as transparency of transactions. Now taxes are imposed by the governments because they want to control everything and, in doing so, want a piece of your earnings, whether you have earned at trading stocks, forex, or even cryptocurrency. Nowadays, authorities are focusing more on crypto than these are on other states of financial markets.
According to them, people have made a fortune in the crypto market as it has seen even a 1000% increase in the price of a cryptocurrency over a period of a few years, this type of growth is not normal in stocks and the forex market. That is why authorities are on an all-time high alert, and the United States Internal Revenue Service has also asked for an increase in the budget, which would help them to enforce more impressive and intense crypto taxation regulations.
Just because you haven’t received any tax documents in relation to your crypto trading doesn’t mean that you have received a get out of jail free card that you can just swipe around to get out of paying taxes for your crypto endeavors. You have to report all of your activities without completely relying on the crypto exchange or trading medium that you used because they might not do it for you; on the other hand, if you fail to do so, then do prepare yourself for a long and clean audit by the taxation authority.
Crypto Profits and Capital Gains Income
You must be familiar with the idea of income tax, you earn some money doing a job or taking on a project, and some part of it is taxable and paid to the government on your behalf, and that is known as income tax. No one can get out of it because the organization or office that you are working in is already deducting a dedicated amount of tax on your income and making it available to the government; it is kind of a fixed scheme and is designed that way so that no one could escape the taxes that they are owed.
Much like that, you have to pay taxes on capital gains from stocks or bonds or even some of the forex assets, and in the same way, whatever trade you are making in the crypto market, if you turn a profit, then a margin of that profit is taxable as capital gains income and you have to pay that honestly and upfront. If you want to examine the overall profit you have made on a certain trade, then you must take into account the selling price of the asset and then subtract from it the cost basis the difference you will get here is the net profit that you have made on a typical cryptocurrency or a trade-in a dedicated one.
Now that you have analyzed the amount of profit that you have made, you have to narrow down the crypto tax liability that you have, and that will depend on the period of time for which you withheld the coin, whether it was for less than a year or more than a year. If you have held the asset initially for less than a year, you will be paying short-term capital gains tax, and that could range from 10% all the way to 37% in the States.
On the other hand, if you did withhold an asset for more than a year, then you are subjected to long term capital gains tax, and the rate for that can be either 0%, 15%, or all the way to 20%, and that will depend on the tax bracket that your situation and scenario fall into.
According to some smart wannabe crypto traders, there is a loophole within the system, and that is if they haven’t made a trade directly into a dedicated cryptocurrency, then they should be exempted from paying the taxes. Well, that is just a myth that they have developed to give their hearts some solemn cheer at the face of paying the inevitable taxes that they are owed. If you think the same, then you must know that all sorts of cryptocurrency uses are essentially subjected to taxation.
That means you don’t have to make a direct investment into a dedicated cryptocurrency to be taxed, if you are simply using the token to make an online purchase or even if you are a miner who is mining cryptocurrency at your home without a proper setup, you are still viable to taxation and all of these elements should be reported on your tax return.
As explained earlier, even if you are buying crypto for the sake of making purchases on the Internet, it might not sound like an income to you, but to the IRS, it most definitely is, and more promptly, it is taxable. Let’s have an insight into how that becomes a taxable income, so you are just going about your day and then have this feeling that you should invest some money into cryptocurrency now that is most definitely taxable because you are making a direct investment.
But on the other hand, if you had bought crypto for the sake of making online purchases and the price went up, but your intention was not to invest your money into it or to make a profit because you are, at the end of the day going to use it to make online purchases. But because the price went up, it is, according to a technicality, a capital gain, so you should report it and be paying taxes on it. On the other hand, people who are paid in cryptocurrency regarding their salary would also have to report the income that they are being paid to the taxation authorities.
A simple way of making the whole transaction easier is to get paid in crypto and then exchange that crypto into simple dollars so that you can have a proper alignment of just how much tax you have to pay on the income that you have earned. On the other hand, if you are into the mining business and mining cryptocurrency even from your home as a small business, then you are still liable to taxation; it might not be about capital gains or personal income but the income you are earning from mining would be subjected into the category of business income which also means that you have to pay tax on that too.
IRS and Crypto Taxes
You must not take IRS for granted on fact whether they have started to track crypto income or not because they are explicitly asking people on the form 1040 if they have in their lives engaged with any kind of crypto activities. This means that they have to be honest and tell truthfully on the form if they have ever received, sent, sold, exchanged, or have acquired any kind of interest in the digital currencies or not.
To some, it might just be a small thing, something that IRS is crossing off of their list for every taxpayer out there but know that the implications of these are going to be pretty significant. You can’t lie to the IRS by saying that you haven’t engaged in any kind of crypto activity, especially if you have, because no matter what you say, they are going to audit you, and if they find that the information that you have shared with them was indeed false, then you could only imagine the implications it would have on your credit score and your financial life.
That is why you don’t answer any question other than truthfully regarding the source of your income and the setups that you have prepared for yourself. It is possible that if you are lying and later on found guilty of making purchases in cryptocurrency or using it for some other purposes, then would be subjected to multiple fines or other types of penalties, or to think that you could outsmart the system and get away with it is plainly a tad too optimistic.
According to the guidelines of the IRS, you don’t have to mark the form with a ‘yes’ if the only type of entanglement that you have ever had with cryptocurrency was to purchase some with dollars. But it is important for you to keep records of those transactions for the crypto that you have bought because it will help you, in the long run, to be able to justify your income and or interactions with the crypto market.
Tax Issues Regarding Crypto Mining
Don’t get the income that you get from the mining of the cryptocurrencies confused with that you gain from investing directly into a crypto-oriented portfolio. The latter is subjected to capital gains, and that is why it is taxable, but the mining income, on the other hand, is treated more like a business income for the person. It also means that you won’t be taxed on the complete income or investment that you have made into your mining business which is why you would only be taxed for the profits that you have churned up during the process.
Running a crypto mining business is fair trade, and that is why IRS is giving such leniency on the taxation aspect, and you would only get taxed on the profit that you have made. The fair market value for each and every token that you have mined would be considered your revenue. It also means that as a business, you have certain opportunities at your hand, which means that you can deduct multiple costs that go directly into the generating of the revenue.
You can have a write-off for the cost that you initially incurred to purchase the mining equipment and or the electricity bill that you are paying on a monthly basis. But this might be subjected to the State that you live in or the taxation bracket that your case falls into. On the broader side of things, if you take logic into effect, then simply joining a mining pool for the sake of making a little money might not get counted as a type of business because it generally isn’t.
You are simply joining another business vendor and putting some money as an investment to make some money from it, and you have no rights and or ownership of that business, so the income you generate from it is not going to be counted as a business earning at all. This might get considered as the hobby income in the eyes of the IRS, and that is your silver lining.
Tax implications in this particular regard are going to be slightly different. If you were thinking that you could deduct your hobby expenses from the hobby income for the sake of reducing your overall tax liability, then it is something that you can’t do. At the end of the day, crypto taxation is something that is extremely new, and still, a lot of ground has to be covered in terms of developing new boundaries and tax regulations along with a proper framework that would make all the pieces fall into order.