When faced with complex tax situations, including gains or losses with virtual currency, you will want to work with a professional for your tax preparation. You may be used to doing your taxes by yourself, or walking into a quick tax service chain, however digital currency can be more tricky. EAs have the knowledge and experience needed to help you with your personal finances and handle your cryptocurrency tax.
Bitcoin: Bitcoin is regarded as the first decentralized cryptocurrency using blockchain technology to facilitate payments and digital transactions. Instead of using a central bank to control the supply of money in an economy (like the Federal Reserve in tandem with the U.S. Department of the Treasury) or third parties to verify transactions (such as your local bank, credit card issuer, and the merchant’s bank), Bitcoin’s blockchain acts as a public ledger of all transactions in the history of Bitcoin. That ledger allows a party to prove they own the Bitcoin they’re trying to use and can help prevent fraud and other unapproved tampering of the currency. A decentralized currency can also make peer-to-peer money transfers (like those between parties in two different countries) faster and less-expensive than traditional currency exchanges involving a third-party institution.
Ether (Ethereum): Ether is the token used to facilitate transactions on the Ethereum network. Ethereum is a platform that uses blockchain technology to enable the creation of smart contracts and other decentralized applications (meaning the software doesn’t have to be distributed on app exchanges like Apple’s (NASDAQ:AAPL) App Store or Alphabet’s (NASDAQ:GOOGL)(NASDAQ:GOOG) Google Play Store, where they might have to give a 30% cut of any revenue to the tech giants). Thus, Ethereum is both a cryptocurrency (the actual coins are measured in units called Ether) and a software development sandbox.
Binance Coin: Binance Coin is available on the Binance cryptocurrency exchange platform (along with other digital coins that are available for trading). Binance Coin can be used as a type of currency, but it also facilitates tokens that can be used to pay fees on the Binance exchange and to power Binance’s DEX (decentralized exchange) for building apps.
XRP (Ripple): XRP is a digital currency based on the digital payments platform RippleNet, built by the company Ripple. It was designed for financial institutions to scale digital payments across the globe and reduce transaction costs associated with typical cross-border funds transfers. Short-term lines of credit can also be extended using XRP.
Tether: Tether is what’s known as a stablecoin, a currency tied to a fiat currency — in this case, the U.S. dollar. The idea behind Tether is to combine the benefits of a cryptocurrency (such as no need for financial intermediaries) with the stability of a currency issued by a sovereign government (versus the wild price fluctuations inherent with many cryptos).
Dogecoin: Originally made as a joke poking fun of rampant speculation on cryptocurrencies, Dogecoin has skyrocketed in value, thanks to support from the likes of Tesla (NASDAQ:TSLA) CEO Elon Musk and investor and Dallas Mavericks owner Mark Cuban. It features a meme of a Shiba Inu dog as a “mascot” and was made to be used a form of digital payment like Bitcoin. However, Dogecoin makes it quicker and easier for payments to be recorded, but it also has no limit on how many coins can be created over time (unlike Bitcoin, which was designed with a cap on how many coins there can be).
Determining how much profit you’ve made and how much you’re liable for in taxes is a bit complicated.
Cashing Out of Crypto
In keeping with standard tax rules, when cashing out cryptocurrency for fiat money like dollars, one will need to know the basis price of the Bitcoin they’re selling.
For example, if you bought Bitcoin at $6,000 and sold it at $8,000 three months later, you’ll pay a short-term capital gains tax (equivalent to one’s income tax) on the $2,000 gained. If the same trade took place over a two-year timeline, long-term capital gains taxes corresponding to one’s tax bracket are applied. This is 0% for those in the 10-15% income bracket, 15% for those in the 25-35% income bracket, and 20% for those in higher brackets.
Selling the cryptocurrencies that one has mined instead of those that they bought previously with fiat is a different story. Since they’re receiving dollars in exchange for mining inputs that can only be described as work (and indeed is so with the term “Proof of Work”), the profit made from selling mined cryptocurrencies is taxed as business income. One is also able to deduct the expenses that went into their mining operation, such as PC hardware and electricity.
The taxes on buying a cup of coffee with cryptocurrency are also convoluted. One must know the basis price of the Bitcoin they used to buy the coffee, then subtract it by the cost of the coffee.
Currently, the tax code allows taxpayers to exclude up to $200 per transaction for foreign currency exchange rate gain, if the gain was derived from a personal purchase, like a cup of coffee. This is known as a de minimis election. But there is no de minimis clause that exempts small transactions, which can create a very tangled tax problem if one is constantly trading crypto and also using it to buy goods and services.
Determining which coins were used to buy the coffee, their basis price and according gains, and then repeating this for every purchase only gets more complicated if the buyer is also trading coins frequently. It’s therefore vital to remember to keep all transaction information for each digital wallet and currency.
Another complication comes with the fact that this only works with gains. Declaring a loss and getting a tax deduction is relevant only for capital asset trades or for-profit transactions. If one buys Bitcoin at $8,000 and then uses it to purchase a pair of jeans when Bitcoin is worth $6,000, they can’t declare this a loss on their tax forms.
Exchanging cryptocurrencies exposes investors to taxes as well. You’re effectively selling Bitcoin if you buy Ethereum with it, so you’ll need to report the difference in Bitcoin’s price between when you bought it and when you spent it on Ethereum, plus make note of the price of Ethereum at its purchase time for when you sell it later.
Many exchanges help crypto traders keep all this information organized by offering free exports of all trading data, which an accountant (or a diligent enthusiast) can use to determine their tax burden. Blockchain solutions are also well-suited to record this data and highlight relevant points of tax interest. Platforms like TrustVerse have smart-contract-based wealth management services that organize one’s digital identity and assets on the blockchain, to ensure that tax and estate obligations are addressed with immutable accuracy according to the asset owner.
It is always recommended to go to a certified accountant when attempting to file cryptocurrency taxes for the first time. While it might seem daunting to tackle a multi-year trading career, it must be done, and it’s getting easier as CPAs and other tax professionals learn more about crypto assets. For now, the IRS is letting people become accustomed to the new way of doing things and has published a guide on amending old tax returns to include cryptocurrency. Savvy traders are already ahead of their obligations and are now focusing on the next year’s crypto market without this cloud of uncertainty over their heads.
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TxSEA makes it easy for enrolled agents in Texas to stay on top of the credits they need to maintain their licensing, as well as provides an opportunity for networking with other EAs in their local area. This can provide helpful information and leads to tax professionals working as enrolled agents today.