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Tax & Tracking
How to Navigate Taxes on Cryptocurrencies
Crypto tax strategy for greater crypto returns
Cryptocurrencies have revolutionized the financial landscape, offering a decentralized and borderless alternative to traditional currencies. Here we'll unravel the intricacies of crypto taxes, providing insights and strategies to help you stay compliant, and optimize your tax liabilities.
Key Takeaway
Taxes on cryptocurrencies is the single most important thing to consider for your crypto success. You can have triple-digit returns but then have your principal wiped out from failure to manage crypto tax. It’s called getting crypto tax REKT where your assets plummet in value and then you end up with a gigantic tax bill. Don’t let that happen to you.
How does cryptocurrency tax work?
Cryptocurrency tax works by identifying various taxable events, including transactions like buying, selling, and exchanging digital assets as well as receiving cryptocurrency as income or through activities like mining or staking.
The first step in crypto tax involves tracking and documenting each transaction, including the purpose, especially for transactions other than trades. Document, capture and memo ALL activity other than trades which are by nature self-evident. Create a running list in your notes app, Evernote or Word for example. If you don't capture it in the moment, then you’ll create more work later or lose the ability to go back and research what happened.
Key Takeaway
Document, document, document. This can’t be overemphasized. Crypto is an asset (obviously) and the information about your crypto is also an asset. When you lose transactions records it becomes VERY expensive to solve.
Different tax rates may apply based on factors such as the holding period—distinguishing between short-term and long-term capital gains or ordinary income. like the income generated through mining, staking or other activities The type of income and the timing of when income is reported are the two most important factors for cryptocurrency tax in every jurisdiction around the world. You have to figure out what types of transactions go into specific “tax buckets” then determine how each tax bucket is taxed (i.e., the tax rate) and when.Â
The total tax liability is the sum of the tax on all the subcategories, the “tax buckets. This is all easier said than done; however, it illustrates the importance of documenting and summarizing transactions even with a lack of regulatory clarity. Staying informed about regulatory changes and seeking professional advice are also essential steps in ensuring accurate and compliant cryptocurrency tax reporting.
Key Takeaway
There is a lack of crypto tax regulatory clarity in many worldwide jurisdictions. Taxpayers still have to navigate crypto complexity and operate on good faith. In some cases, there is more uncertainty around the taxation of some crypto events than clear guidance. Don’t let this stop you because the benefits of crypto far outweigh tax issues.
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Do you have to pay taxes on cryptocurrency?
The taxation of cryptocurrency varies depending on your jurisdiction and how you use your digital assets. In many countries, tax authorities have developed guidelines to address the taxation of cryptocurrencies, but these regulations can differ significantly and still need more clarity in many cases.
Cryptocurrencies are an asset, and all assets are already taxed by default under existing regulatory regimes in every country around the world. Crypto is a new asset class but that doesn’t mean it magically escapes taxation The question is where does the “new asset” tuck into a given set of regulations. In many cases, the current regulatory language doesn’t allow for a good fit; therefore, regulators have to modify and/or create new regs for crypto tax clarity. U.S. taxation is a good example of this.
Here are some general considerations:Â
Capital gains tax
In numerous jurisdictions, including the United States, the United Kingdom, Canada, and others, cryptocurrencies are typically treated as property for tax purposes. Therefore, when you sell or exchange cryptocurrencies, you may incur capital gains or losses. The tax treatment of these gains can be subject to different rates based on factors such as the duration of ownership (short-term vs. long-term).
Ordinary income tax
If you receive cryptocurrency as payment for goods or services, it may be considered taxable income. The value of the received cryptocurrency at the time of the transaction would be included in your taxable income.
Mining and staking
If you mine or stake cryptocurrencies, the rewards you receive may be subject to income tax. The valuation of these rewards and the timing of taxation can vary based on local regulations. In the U.S., the IRS addressed mining income as ordinary income in 2014, yet there is still no definitive clarity on taxation of staking rewards as of 2023.Â
Forks and airdrops
In some jurisdictions, receiving cryptocurrency from a fork or airdrop might be considered taxable income. The fair market value of the new coins or tokens at the time of receipt could be subject to taxation. The question is what does “receipt” mean and when is the token considered received for purposes of including it in income.
Reporting requirements
Individuals and businesses must report their cryptocurrency transactions when filing annual tax returns. Failure to report these transactions accurately could lead to penalties or legal consequences. Crypto is facing increased regulatory scrutiny because of the actual or perceived threat that taxpayers are not reporting crypto.
Keep in mind that tax regulations related to cryptocurrencies are still evolving, and there may be variations in interpretations and enforcement across jurisdictions. Some countries have introduced specific guidelines, while others are in the process of developing clearer frameworks. Be sure to consult with a tax professional or financial advisor who is knowledgeable about cryptocurrency taxation in your jurisdiction to ensure compliance with local laws and regulations.
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Key Takeaway
Always act in good faith and treat your crypto transactions consistently. True crypto tax experts are in short supply but consider consulting with an expert even if you self-prepare your tax return.Â
Unraveling the complexities of crypto taxes
Navigating the regulatory landscape in cryptocurrency can be challenging. Governments worldwide are grappling with how to tax and regulate this emerging asset class. Understanding the evolving regulatory environment is the first step in managing your crypto tax obligations. Even though the U.S. defines cryptocurrencies as property, for example, it’s most akin to the taxation of securities and many activities like trading on exchanges look just like trading securities. However, the U.S. regulations don’t specifically define “digital assets” and securities-related taxation that may otherwise apply can’t be applied without changes to the laws. These definitional changes have happened in the U.S. with the passage of the Infrastructure Act.
Understanding crypto tax rates
Cryptocurrency tax rates vary globally, ranging from capital gains taxes to income taxes.Â
The tax rates on cryptocurrencies are influenced by several factors, and they can vary significantly based on the jurisdiction and the nature of the cryptocurrency transaction. Some tax rates are obviously higher than others so the goal is to shift tax to a lower tax rate bucket when possible. Having a good working knowledge is huge for your crypto strategy because some things can’t be changed after the fact. For example, if you sell crypto one day before qualifying for a long-term period it could double your tax rate.
Here are some key factors that influence tax rates on cryptocurrencies:
Jurisdiction
Tax regulations for cryptocurrencies vary from one country to another. Some countries have embraced digital currencies and provide clear guidelines, while others may have stringent or ambiguous regulations. Some countries have low to no tax on crypto gains while other countries have high tax rates and unfavorable treatment relative to similar types of income. Â
Holding period
The duration for which you hold a cryptocurrency before selling or disposing of it can affect the tax rate. Many jurisdictions distinguish between short-term and long-term capital gains, with different tax rates applied based on the holding period. Long term could be 12 months or 24 months, for example, and the tax rate can be as low as 0%. The U.S. even has a 0% long-term tax rate for a small range of gains. The difference between long and short term can be 2X to 3X higher (or infinite if comparing a 0% rate), making holding period one of the key tax strategies.Â
Tax classification
Cryptocurrencies are often classified differently for tax purposes. They may be considered as property, commodities, securities or even as currency in some jurisdictions. In conjunction with holding period, the classification or type of the income is another big factor because different types of income have different rates. However, tax type limitations are another income type factor that most people don’t consider. For example, in the U.S. capital losses are limited to $3,000 per year and can’t be carried back to prior years. In some cases, the losses with one type of income can’t be offset with another.
Key Takeaway
Managing total tax liability has lots of interrelated moving parts and non-crypto income and deductions can affect and determine the outcome of crypto-related income and vice versa. Effective crypto tax management requires you be savvy with your overall tax picture.
Income tax vs. capital gains tax
The type of income generated from cryptocurrency transactions can influence the tax rate. If the profits are treated as capital gains, the tax rate may be different from income generated through mining, staking, or other activities.Â
Taxpayer's income bracket
In some jurisdictions, the taxpayer's overall income level can influence the tax rate on cryptocurrency gains. Higher-income individuals may be subject to higher tax rates on their crypto earnings and/or other earnings. Many countries have a graduated tax rate system which means the more you make, the more tax you pay. There are a series of tax brackets for certain income amounts like $0 to $15,000, for example, and so on. The tax brackets have increasingly higher rates. So, a high-income taxpayer may end up in every tax bracket thus having parts of their total income taxed at every tax rate. This explains why all income is inextricably combined as a whole and tax planning is challenging.
EXAMPLE
Bob got an airdrop of XYZ coin worth $16,500 and he wants to know how much tax he owes on the airdrop. The answer is another question: What is your marginal tax rate? Meaning, what is your current highest tax bracket based on all your other income.
Tax reporting method
The cost method basis used to calculate and report cryptocurrency gains can impact the tax rate. Different jurisdictions may allow for different methodologies, such as First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or Highest-Price-First-Out (HPFO) which can affect the amount of taxable gains. Some crypto tax software has up to 15 different cost basis methods.
Key Takeaway
With everything else equal, a cost basis method is single biggest factor in determining the amount of your gains and losses. If Alice applies FIFO and HPFO to the same set of transactions her gains could be wildly different.
Avoid pitfalls, eliminate headaches, and produce useful financial data. Never overpay or under report your taxes.
Get the Crypto Tax Blueprint CourseUse of cryptocurrency
Different types of business activity can affect the tax rate. For example, if business of dealing cryptocurrencies like an exchange, then the crypto is inventory and the related income is ordinary. If Bob uses crypto as an investment he’ll have capital gains. If Alice is a crypto trader then her trader status may allow her to take certain business related expenses.
Regulatory changes
Cryptocurrency tax regulations are still evolving in many jurisdictions. Changes in these regulations can directly impact taxpayers in many ways. It's essential for investors to stay informed about any updates or amendments to tax laws related to cryptocurrencies. Some countries incentivize crypto investment while others discourage it through high tax schemes.Â
Specific cryptocurrency activities
Different activities in the crypto space may have specific tax implications such as:
- Trading
- Mining
- Staking
- Airdrops
- Token swaps
- Wrapped tokens
- Liquid staking tokens (LSTs)
- LP rewards
- NFTs
- Impermanent/divergent losses
- Chain-split tokens (forks)
- Purchase of goods and services
- Accepting crypto for goods and services
The nature of the activity can influence the applicable tax rates so the goal is to accurately track all cryptocurrency activities into their respective buckets.
It's important for cryptocurrency investors to be aware of these factors and seek professional advice to navigate the complex landscape of cryptocurrency taxation in their specific jurisdiction. Tax laws are subject to change, and staying informed is crucial for compliance and effective tax planning which can’t be overstated. Â
Key Takeaway
Mastering cryptocurrency transactions tracking solves at least 90% of cryptocurrency tax issues. Taxpayers want to know how various crypto activities are taxed; however, a correct tax rate applied to incorrect trades or staking rewards is worse than not having clarity on tax treatment. How to report cryptocurrency taxes is a last-mile exercise, albeit a very important one.
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As always your goal is to get a Crypto Bullseye™.
Content InsightÂ
This content has been created through a collaborative effort, combining the capabilities of artificial intelligence (AI) technology and the expertise of a seasoned professional with extensive experience in the crypto space. While AI played a role in generating portions of this material, it has been carefully reviewed, researched, and refined by a human expert to ensure accuracy, relevance, and a nuanced understanding of the subject matter. The information presented herein reflects a synthesis of AI-generated insights and the real-world knowledge contributed by the human expert, aiming to provide a comprehensive and well-informed perspective on the topic. Users are encouraged to verify details independently and seek advice from qualified professionals before making any financial or investment decisions.
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