In 1789, Benjamin Franklin wrote the famous thesis that “in this world, nothing can be said to be certain, except death and taxes” and the words ring true more than 200 years later. You might be able to “escape” death if what some religions teach turn out to be true, but there’s no way you can escape paying taxes to Uncle Sam. The creation of Bitcoin as a decentralized and practically anonymous form of exchange devoid of government influences, initially suggested that the government won’t be able to levy taxes on cryptocurrency activities. However, the developments in the last couple of months suggest that Uncle Sam always finds a way to get his due.
The IRS will soon send you a tax bill for Bitcoin gains
In late 2017, the IRS secured a court ruling compelling Coinbase (a U.S. cryptocurrency exchange) to hand over details of about 14,355 accounts of its users to the IRS. US Magistrate Judge Jacqueline Scott Corley in her ruling noted that handing over the data to the IRS is not a breach of confidentiality because “It’s legitimate for them (the IRS) to investigate whether people are making money on their bitcoin purchases … I have to give tremendous discretion to the agency as to how they investigate.”
The IRS had initially been after about 500,000 user accounts on Coinbase noting that there’s a reporting gap. The IRS made a case that out of the 500,000 accounts that Coinbase managed between 2013 and 2015, only 900 users reported Bitcoin gains/losses in the same period.
The IRS eventually altered its strategy and its attention is now on accounts “with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013-15 period.” Hence, you probably won’t get a tax bill if you haven’t done $20,000 in Bitcoin transactions during the period under review.
Here’s a simple approach for navigating the tax maze on cryptocurrencies
Bitcoin is considered a capital asset taxed as property
If you plan to sell your Bitcoin holdings this year for profit, you’ll be required to pay capital gain taxes because Bitcoin is considered a capital asset taxed as property. If you have owned or held the Bitcoin for less than one year, you can expect to pay short-term capital gain taxes up to the tune of 39.6%. You can also expect to pay state taxes up to 13% of your gains. If you have owned/held your Bitcoin for more than one year, you can expect to pay a lower long-term capital gain tax somewhere between 0% and 20% depending on your filing status.
Changing Bitcoin to Ethereum, Ripple or other cryptocurrencies won’t excuse you from taxes
You might be tempted to think that capital gain taxes are only due when you sell your Bitcoin for fiat. A seemingly smart way to avoid paying taxes will be to trade Bitcoin for other assets such as Ripple or Ethereum. The problem, however, is that you have successfully complicated your tax reporting because you’ll need to note the dollar value of the Bitcoin you converted to another asset, and you’ll still need to pay the capital gain tax when you sell the new cryptocurrency. Capital gain taxes are levied on cryptocurrencies, Bitcoin is only one of the 1,380 cryptocurrencies in the market.
Income paid in Bitcoin is subject to income tax
Some freelancers, contractors, and employees in techie roles are paid with Bitcoin for their services. Income earned in Bitcoin is subject to income tax. Employers are required to report such earnings to the IRS using W-2 forms and employees are required to reports all their wages (including those earned in Bitcoin) on their W-2 forms. Of course, you’ll need to calculate the dollar value of the Bitcoin on the day it was paid.
Other stakeholders in the cryptocurrency industry such as miners will also be required to pay taxes on the Bitcoin ‘earned’ from their mining activities. Miners can however report their Bitcoin earnings as gross earnings and then subtract all the available tax deductions such as cost of computers, electricity, and bandwidth before paying the self-employment tax.
The IRS sees new coins gotten from cryptocurrency forks as taxable income
Cryptocurrency is still in infancy and it is still in the process of gradual evolvement as problems surface and are fixed. One of the solutions to improving transaction times, costs, and security of cryptocurrencies is forking – hard forks or soft forks depending on the circumstances. When a fork happens, a new coin is created and people who owned the original coin now end up having two different coins. You could think of a fork as a stock split or spin-off. If you have new coins after a fork, the IRS will still consider the new coin as taxable income. For what it’s worth, you’ll be required to pay taxes on the free money in the fiat economy; hence, it’s not unthinkable that the IRS will expect you pay taxes on “free” coins in the cryptocurrency economy.