The IRS describes Bitcoin and other cryptocurrencies as digital representations of value. Virtual currencies like Bitcoin use a distributed and encrypted blockchain network to process transactions. Besides, no bank or central authority regulates Bitcoin transactions the way they do to fiat money. Since 2019, the Federal taxation documents now ask people about Bitcoin and other cryptocurrencies. That means using crypto could have tax implications. Here are things to know about paying taxes on Bitcoin.
Cryptocurrency as Property
Many people have used cryptocurrencies to invest and trade on exchange platforms such as crypto trader, without remitting taxes on their profits. However, the IRS says doing so contributes to non-compliance that could attract penalties. The IRS has labeled cryptocurrencies like Bitcoin as property since 2014, subject to taxation laws.
The IRS stipulates taxpayers to report transactions involving virtual currencies on their tax returns. That means they must determine Bitcoin’s fair market value as of the transaction date. Taxpayers can determine that value by converting their Bitcoin funds into US dollars or other local currencies, assuming the exchange rate relies on market demand and supply.
Ensuring compliance with crypto taxation laws requires users to observe record-keeping solid practices. However, that is not necessary with Bitcoin since it records and validates all transactions on a digital public ledger. That makes it easier to re-construct transaction records when filing tax returns.
As hinted above, the IRS expects taxpayers to file tax returns dating back to 2014, when they began taxing cryptocurrency gains. They have recently issued warning letters to taxpayers who have been involved in crypto transactions to file amended returns and pay back taxes.
In taxation form 1040, the IRS now asks taxpayers if they have received, sold, sent, or exchanged crypto or acquired financial interest from any virtual currency. Those who have engaged in any of those activities must file the reports in their tax returns.
Crypto and Capital Gains Taxes
The IRS considers the funds received from trading Bitcoin and other cryptocurrencies as capital assets, subject to capital gains taxes. Taxpayers can pay the taxes in the short term or long term. Short-term capital gains taxes applied to properties held for less than one year and taxed as regular income. Long-term capital gains taxes affect assets held for more than twelve months.
The regulator calculates those taxes similarly to any other capital gains and losses. As of 2020, the capital gains rates were 0%, 15%, or 20%, based on an individual or business’ taxable income.
However, the IRS does not consider property sold as part of a trade or business capital asset. Thus, the property is subject to the taxes levied on ordinary incomes. That also applies to digital currency sales, but the IRS will independently determine the gain or loss based on your intentions or reasons for selling.
Assessing Taxable Crypto Transactions
Many ways exist for the IRS to assess whether taxpayers have engaged in taxable cryptocurrency transactions. For instance, every business that pays over $600 to non-employees or as wages must report the income to the IRS. Besides, taxpayers must also truthfully answer the question about receiving, selling, sending or exchanging, or generating interest from crypto on their 1040 form.
However, the tax authorities will not rely on taxpayers’ honor since it believes many crypto users would still ignore their warnings. Thus, they have begun an intensive digital currency compliance campaign to educate the public about the taxation laws that apply to crypto users. They have also instituted a Criminal Investigation Cyber Crimes Unit to snuff out illegal activity in crypto transactions.
Nevertheless, the IRS website can offer you comprehensive information and updates about the taxes that apply to Bitcoin transactions and how to file them in your returns for compliance.