The United States is one of the biggest markets for cryptocurrencies in the world. Earlier this year, a report showed that about 21% of all adult Americans have either used crypto or tried to use it at some point in their lives.
And with some of the world’s biggest and most prominent crypto companies focusing on the U.S. market, the industry’s growth in the world’s most prosperous nation is quite impressive.
Just as well, the growth of the crypto space means that regulators and tax authorities are starting to build structures for collecting crypto taxes in the US.
The space remains largely unregulated, but the Internal Revenue Service (IRS) has so far been more active in enforcing tax collection and recording in the US than most other financial regulators have been with their jurisdictions.
If you’re an American investor or a prospective one, you need to understand the workings of crypto taxes in the US. This article will give you a proper guide, explaining all you need to know to get started.
How Crypto Taxes in the US Work
As we all know, the United States government has given broad powers to the Internal Revenue Service to pursue tax compliance.
And over the past few years, the agency has been active in ensuring compliance from the cryptocurrency sector.
This is, although many other financial watchdogs have yet to come up with a proper framework for regulating cryptocurrencies.
As soon as digital assets became mainstream, they got on the IRS’ radar. In a notice published back in 2014, the IRS made clear that it views cryptocurrencies as “property.” This classification holds until now, and it has even expanded to refer to non-fungible tokens (NFTs) and other subsections of the crypto space.
Thanks to this classification, the IRS now mandates that capital gains taxes be paid on most taxable actions involving cryptocurrencies.
This is similar to how stocks are treated. However, cryptocurrencies received from some activities are treated as income. So, they will be subject instead to income tax requirements.
Of course, with cryptocurrencies being treated as property, you’re not taxed when you hold one – no matter how long you hold it for.
When Do You Pay Crypto Taxes in the US?
To understand when taxes are incurred, it’s important to know taxable and non-taxable crypto transactions in the US.
As explained earlier, cryptocurrencies generally incur two types of taxes – capital gains taxes and income taxes. For capital gains taxes, the following are classified as taxable events
Crypto Sales: Essentially, selling cryptocurrencies for fiat (the dollar, British Pound, etc.). For crypto sales, you need to remember your cost basis – this is the total price you paid for the asset, and it includes fees and any other additional charges.
Subtract the cost basis from the coin’s fair market value when you’re selling it, and you know your capital gains or loss.
Crypto Gifts and Inheritances: If you’re sending crypto to someone as a gift or leaving crypto as an inheritance for your loved ones, they are subject to taxes. Gifts are subject to a tax rate between 18% and 40%, as long as the crypto is worth over $16,000 in 2022.
On the other hand, inheritances can be subject to estate taxes if the estate itself crosses $12.06 million in value in 2022.
Crypto Payments: If you use crypto to purchase goods and services, you incur taxes. A sales tax is incurred once you make the payment, and the recipient also has to pay capital gains taxes if the coin you sent to them increases in value after you made the payment.
Crypto Swaps: If you trade one coin for another, you also incur taxes. You’re basically changing one coin to another, and you need to report the gains or losses on the transaction. Interestingly, this rule also applies to buying NFTs with crypto.
In general, you should keep in mind that you only owe taxes on any capital gains you make from these transactions – not the full amount of the assets. Remember the cost basis explanation, and use that to ascertain your capital gains. Then, pay taxes on those gains alone.
So far, the IRS is yet to determine whether minting tokens – including traditional cryptocurrencies or NFTs – can be considered a taxable event.
It’s also unclear if you create a taxable transaction when you withdraw liquidity from liquidity pools in decentralized finance (DeFi) protocols. If you’ve made any of these transactions, then you might want to seek some professional advice.
Moving on, you should also know when your activities incur income taxes. These activities include:
Airdrops: You get to pay income taxes if you’re the beneficiary or an airdrop or a token giveaway – especially from official sources.
DeFi Lending: Lending has so far become one of the most popular activities in the DeFi space. Investors can lend liquidity and earn interest as a result. However, the interest earned carries an income tax requirement.
Crypto Mining: A crypto miner verifies transactions on a blockchain and earns rewards in the form of crypto. Those rewards earned are subject to income taxes too.
Usually, mining rewards for individual miners are classified as ordinary income.
However, you can enjoy an exception if the mining operation is a business. Here, you can subtract business costs (hardware, maintenance, electricity, etc.) as part of your cost basis from your earned rewards.
Crypto Income: General crypto income is also subject to the income tax. With many people preferring to get paid in crypto these days, you should know that any crypto earned as income will be taxed.
For now, there aren’t any clear laws surrounding crypto earned through staking. While many report staking rewards as income, there is a case against the IRS right now asking that these rewards should only be taxed when they’re sold; not when they’re initially earned.
How Much Do You Pay in Crypto Taxes in the US?
Now that we understand the taxable events that govern the US market, let’s also consider the applicable tax rates.
Generally, the IRS taxes profits based on time periods. Short-term capital gains taxes are incurred on the sale of cryptocurrencies that have been held for less than a year. And for 2022, that tax rate stands between 0% and 37%, depending on the income level.
Once the asset has been held for a year or more, it triggers long-term capital gains taxes. Here, the tax rate stands between 0% and 20% for the 2022 tax year, depending on the income.
Getting Ready For The Tax Season
Tax season can be challenging for many people. There are so many considerations, and the fact that there’s a deadline also puts some additional pressure on you to get your taxes filed as quickly as possible. Things are especially challenging for crypto investors.
The market remains highly unregulated, and with so much murkiness surrounding the status of digital assets, ensuring tax compliance can be difficult.
If you’re serious about paying crypto taxes in the US, the first thing will be to collate all of your crypto transactions and activity. For most people, this includes logging all your trades.
For others, you also need to consider places where you spent crypto – or dabbled in activities like NFT minting, airdrops, and DeFi. Considering how cumbersome this is, we recommend keeping track of all your trades throughout the tax year.
After collating your transaction history, you need to understand your capital gains or losses. Several tax compliance platforms in the crypto space – and even a few crypto exchanges – can help with this.
Then, you will have to fill both your Form 8948, Sales and Dispositions of Capital Assets. And, you should add that to the IRS Form Schedule D.
Any cryptocurrencies you earn as income should be stated in the Schedule 1 Form 1040, Additional Income and Adjustments to Income.
And, if you get this income from self-employed activity – such as individual mining, payment as a freelancer, etc. – you should add them to the Schedule C, which is for sole proprietors in the country.
After filling the appropriate forms, submit them and pay the tax you owe before the deadline.
Do You Need A Software Or Tax Accountant?
Considering how challenging it is to understand your tax liability as a crypto investor or owner, it is a good idea to get professional advice. This advice could come from a seasoned tax professional, although you could also sign up to use tax compliance and reporting software that can help you out.
As explained, some major exchanges in the US offer tax compliance tools. However, there are also dedicated tax tools that can help with tasks like collecting your transaction history and even calculating your capital gains or losses.
To ensure that you don’t make any mistakes with your filing, help from a software or accountant is always welcome.
Tax season is upon us. And as a cryptocurrency investor, ensuring tax compliance is even more challenging due to the relative lack of regulatory clarity in the industry. Nevertheless, the IRS is making good progress when it comes to helping crypto investors and holders to understand their tax obligations.
For Americans, understanding crypto taxes in the US starts with knowing your taxable and non-taxable events. From there, you can understand how much you need to pay and work on completing your filing.
However, if you need some help, don’t hesitate to call on a tax accountant or sign up for a tax compliance software that can provide additional clarity.