To begin with, let’s clarify what cryptocurrency is and what it does. This is a form of digital currency that is created and used to work as a medium of exchange and wealth storage. Transactions are verified, and new units designed with the help of secure technology.
The best-known example of such cryptocurrency is, of course, what is known as Bitcoin. This was created in 2009, and is today the world’s largest cryptocurrency by market cap. As with other cryptocurrencies, Bitcoin is created, traded, and stored with the use of blockchain, which is a virtual ledger system.
Transactions are carried out with the help of private online codes, or keys, along with Bitcoin wallets, which are devices that let investors track ownership and value. In 2017, the price of Bitcoin rose from a little under USD 1,000 to USD 19,000, a rise of more than 1,400%.
One of the critical features of such cryptocurrency is that it is decentralized. It is generated and traded by peer-to-peer technology, not issued or backed by banks or governments.
The Tax Implications of Bitcoin
Decentralization gives Bitcoin a degree of freedom and flexibility. Investors prize this because of its autonomy. However, decentralization can also make things complicated when it comes to taxes.
Countries have different taxation policies, depending on how virtual currency is held and used. In the United States, for example, it can be generally treated as property. In many cases, the tax principles applicable to property transactions also apply to virtual currency dealings.
There’s no doubt that the IRS has started to view dealings in Bitcoin very seriously. In a recent press release, IRS Commissioner Chuck Rettig said, “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers understand and meet their obligations.”
In general, other countries follow similar principles. Let’s take a deeper dive into the tax implications of such policies for cryptocurrency investors. These are based on IRS rules, so you should check the applicability in the country of your residence.
Taxes on Bitcoin for Payments
When Bitcoin is used by employers to pay for goods and services, it is taxed as income. You should report such employee earnings to the IRS on the relevant forms.
Before that, you need to convert the value into USD on the date of payment. Wages paid in virtual currency are treated as dollar wages and are subject to withholding. Therefore, employees must report this, too.
If you’re self-employed, the same principle applies. Gains and losses from such sales should be converted into USD and then featured in tax returns.
Other Bitcoin Taxes on Income
Some people add to a virtual blockchain by solving complex, virtual puzzles on computers. In this way, they validate transactions and refresh the digital ledger. They earn cryptocurrency for this work without paying money for it and are known as Bitcoin miners.
Bitcoin miners should report receipt of virtual currency as income to the IRS. They must include it in gross income after converting the amount into the USD value on the day it was earned. Self-employed Bitcoin miners are allowed standard tax deductions.
Holding Bitcoin as an Asset
Many people store Bitcoin as a capital asset because of long-term appreciation. In such cases, it is taxed as property, and the regulations for property transactions are applicable.
This is taxed in the same way as gains or losses from stocks and bonds. They are seen as capital assets, and sales are subject to capital gain or loss.
Provisions for Losses and Reductions
As is the case with other income, those who donate Bitcoin to notified charities can qualify for reduced tax liabilities. The amount in USD that is received from the sale of a donation can be invested by the donor, who receives a tax deduction for this purpose.
This reduction applies to those who itemize their tax returns, instead of opting for a flat-dollar deduction. Do note that only donations to eligible charitable foundations are considered in this case.
Cryptocurrency losses can also be used to offset capital gains. Sometimes, they can be carried forward. These are subject to the same regulations that apply to other forms of capital gains and losses.
When is Bitcoin Not Taxable?
So far, the regulations state that cryptocurrency is taxable only under certain circumstances. For example, when it is traded or exchanged against currency or traded for another form of cryptocurrency. As we have seen, when Bitcoin is used for payments, it is also taxable.
However, transferring cryptocurrency as a gift is not taxable if this is within the gift tax exemption amount. Transfers between digital wallets are also not subject to capital gains and losses taxes.
Buying Bitcoin with USD is not taxable, and capital gains tax is applicable only when you trade, use, or sell your cryptocurrency.
Making Bitcoin Taxation Simple
The rules clearly state that it is the individual who is responsible for maintaining records of cryptocurrency dealings. It is up to you to carefully log all transactions related to Bitcoin, with relevant details such as the value in USD as of that date.
This can be a detailed and lengthy process, which is why many Bitcoin investors and traders look for the best bitcoin tax calculator available. This is an extremely convenient way to estimate how much they owe in taxes. Transaction data is first imported from digital wallets, and reports are generated to help with tax reporting and filing.
It helps to go through online crypto tax software reviews to get an idea of the advantages of such online calculators. For example, you can get to know whether they support major exchanges, cryptocurrencies, and fiat currencies. Zenledger is one such software that is great for cryptocurrency tax calculations.
Once you have such software up and running, you’ll find it a friendly partner and expert guide to navigate the world of Bitcoin tax regulations and filing. If you’re a trader or investor, it’s an essential tool that you should purchase.