Are there taxes on Bitcoin?

Are there taxes on Bitcoin?

2023 Capital Gains Tax Rates
login status 0% tax rate 15% tax rate 20% tax rate
single Up to $44,625 $44,626 to $492,300 More than $492,300
head of household Up to $59,750 $59,751 to $523,050 More than $523,050
Married filing jointly Up to $89,250 $89,251 to $553,850 More than $553,850
Register married separately Up to $44,625 $44,626 to $276,900 More than $276,900

Bitcoin taxable transactions

The IRS has provided specific guidance on digital asset transactions that must be included on a tax return. Note that the volume of these transactions can make tracking all transactions difficult; Cryptocurrency investors and users are advised to consult tax advisors to ensure that all of the following transactions are adequately recorded:

  • Selling a digital asset for Fiat
  • Exchanging a digital asset for property, goods, or services
  • Exchanging or trading one digital asset for another digital asset
  • Receiving a digital asset as payment for goods or services
  • Obtaining a new digital asset as a result of a hard fork
  • Obtaining a new digital asset as a result of mining or staking activities
  • Receiving a digital asset as a result of an airdrop
  • Any other disposition of a financial interest in a digital asset
  • Receiving or transferring a digital asset free of charge (without providing anything in return) that does not qualify as a gift in good faith
  • Giving a digital asset as a good faith gift if the donor exceeds the annual gift exclusion amount

Bitcoin Tax Base

In the broadest sense, Bitcoin’s tax base, used to determine your profit or loss, is the cost at which the digital currency was acquired. For example, let’s say 100,000 satoshi were acquired when bitcoin was trading at $20,000/coin. The cost basis of the acquisition would be $20.

In the example above, if the bitcoin sold for $25, there would be a taxable gain of $5. If the bitcoin sold for $14, there would be a $6 loss.

Bitcoin’s tax base becomes more complicated when less simple transactions take place. For example, it may be free for an investor to receive airdrop tokens or tokens in exchange for a service. In most of these situations, Bitcoin (or other digital currencies) would have a basis equal to its fair market value at the time of purchase. This tax treatment is similar to that of stocks and bonds.

Tax Implications of Bitcoin Mining

Cryptocurrency mining is also considered a taxable event. The coin’s fair market value or cost basis is its price at the time you mined it. The good news is that you can make business deductions for equipment and resources used in mining. The nature of these deductions depends on whether you mined the cryptocurrencies for personal or individual gain.

If you operate a mining business, you can make the deductions to reduce your tax burden. But you cannot make these deductions if you have been mining cryptocurrencies for personal gain.

Tax implications of swaps

Some have argued that the conversion of one cryptocurrency to another, say bitcoin to ether, should be classified as a like-for-like transfer under Section 1031 of the Internal Revenue Code. The IRS allows you to defer income tax on such transactions.

However, in an Office of Chief Counsel memorandum released on June 18, 2021, the IRS ruled that such an exchange does not qualify as a like-for-like exchange under Section 1031. Additionally, the Tax Cuts and Jobs Act (TCJA) 2017 put an end to this practice by clarifying that transfers of the same nature are limited to property transactions.

If you receive cryptocurrency in a transaction conducted through an exchange, the value of the digital currency received is recorded by the exchange at the time of the transaction. If the transaction is done off-chain, the basis of the exchange is the fair market value of the exchange. Otherwise, the centralized or decentralized exchange will record the basis in their distributed ledger.

Tax implications of hard forks

Hard forks of a cryptocurrency occur when a blockchain split occurs, meaning protocols change. A new coin with differences in mining and use cases from its predecessor is created. Holders of the original cryptocurrency can receive new coins. Also known as airdrop, this practice is also used as a marketing tactic by developers of new coins to induce demand and usage.

In a 2019 ruling, the IRS clarified that hard forks do not result in gross proceeds if the wallet holder does not receive units of the cryptocurrency. Airdrops, on the other hand, qualify as gross income after the holder has received units of a new cryptocurrency either after a hard fork or through marketers of a coin. In the latter case, the amount and timing that a crypto wallet holder receives the new coins determines the tax level. Airdrops are taxed as ordinary income.

Tax implications of gifting bitcoin

Cryptocurrency donations are treated similarly to cash donations. They are tax deductible, although donors are limited on how much they can deduct based on their AGI. An appraiser will assign a fair market value to the coin based on its market price at the time of donation. The donor does not have to pay any taxes on the course profit.

The IRS instituted an annual gift tax exemption each year. In 2022, taxpayers will be granted an annual disclaimer per gift recipient for gifts of up to $16,000. For 2023, that limit has been increased to $17,000.

Special considerations

The volatility of the bitcoin price makes it difficult to determine the cryptocurrency’s fair value in buy and sell transactions. It is highly recommended to track transactions as they occur, as the need for financial information after the fact (even across distributed ledgers) can prove difficult.

It is also difficult to identify the appropriate accounting method to use when taxing cryptocurrencies. Last In, First Out (LIFO) and Highest In, First Out (HIFO) have the potential to reduce taxes, but the IRS has approved very few instances of their use for crypto traders. First In, First Out is the most commonly used method for cryptocurrency settlement.

Cryptocurrency donated to a charitable organization often does not result in a taxable transaction. The donation is often based on the fair market value of the digital currency at the time of the transaction.

How can I avoid paying taxes on Bitcoin?

The easiest way to avoid taxes on Bitcoin is to not sell digital currencies during the tax year. Although receiving bitcoin as an airdrop or in exchange for a service has tax implications, most taxable events are triggered by the sale or exchange of the cryptocurrency.

Does the IRS Know I Own Bitcoin?

Some centralized exchanges have “Know Your Client” reporting requirements, which require investors to upload their photo ID and some personal information. If your trading platform provides you with a Form 1099-B or 1099-K, the IRS will be notified that you have transacted with the trading platform.

What Happens If You Don’t Report Taxes on Bitcoin to the IRS?

Tax evasion occurs when taxpayers knowingly fail to remit taxes on any source of income, whether related to cryptocurrency, wages, salaries, stocks, real estate, or any other investment. If the IRS has reason to believe that you have engaged in tax fraud, they can audit you. Keep in mind that trading platforms may file tax returns and notify the IRS that you have been involved in cryptocurrency transactions.

The final result

Cryptocurrency is an exciting, volatile, risky and emerging market. Those investing, trading, or doing business in Bitcoin should take care to understand the tax implications of their movements in the digital currency. Most transactions trigger taxable events, and the taxable basis of owned bitcoin is usually either the cost basis or the fair market value at acquisition. Knowingly failing to pay taxes on cryptocurrency transactions is considered tax fraud.

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