Crypto tax expert, Clinton Donnelly answers all your top questions about crypto taxes in the U.S.
How Is Crypto Taxed In The US?
The IRS classifies cryptocurrencies as property, and property is taxed when you sell it.
If I buy a piece of art and the art price goes up and sell it, I will profit or a gain. The gain over what you bought it at is taxed, not the price you sold it at.
The unique thing about cryptocurrencies is that if you trade one currency to another currency, this gives rise to one of the most asked questions. “Why am I taxed when I trade one coin for another coin?”
How Are Crypto Taxes Calculated?
I am paraphrasing precisely what the tax law says here:
It says that "a taxpayer realizes a gain or a loss anytime they sell or exchange property (cryptocurrencies are property); the gain can be realized in cash that you receive and in the fair market value of any property received."
Is Crypto-To-Crypto Trading Considered A Taxable Event In The Same Way Crypto-To-Fiat Is?
When we're making crypto-to-crypto trades, there's no cash, but we're receiving a new currency at a fair market value. That is considered the measure of how much the gain is.
With cryptocurrency, we have what is called a gain. In the US, we look at that gain, and we decide, how long have I held this gain?
If you hold an asset for more than a year, you get to benefit from what's called long-term capital gains treatment, which for most people are around a 15% tax rate on the net gain.
The net gain is all your winners minus all your losers. At the end of the year, hopefully, you'll have more winners than losers. If you haven't held for a year, then that's considered a short-term gain.
Are Crypto Taxed As Income Or As Capital Gains?
Short-term gains are taxed like ordinary income (ordinary income would be interest, dividends, and wages). These are all taxed at your marginal tax bracket, which increases as you make more money. That's what ordinary gains are.
So the most significant way to reduce your taxes is to hold onto a coin for a year before you sell it. And once you have it for a year, then you can sell it at any point in that time, and you're going to get the long-term gains rate.
Should crypto assets be treated in the same manner that currencies vs. equities are treated from a capital gains perspective?
What Are Forms Like 1040, 1099-K And 1099-MISC Forms All About?
The IRS says that we have what they call a voluntary tax system as Americans. The IRS depends on people to report how much they've made honesty.
To increase their level of honesty, the IRS has mandated that people who payout file forms at the end of the year, reporting these payouts to the IRS.
In the case of an employee, a company must pay their wages and withhold some taxes. That withholding is reported on the W2 form.
Other types of payouts may get what's called a 1099 form. There are about a dozen of them, and they're used in various ways.
There's a 1099INT for interest and a 1099DIV for dividends. The most common one we see in the crypto space is the 1099K.
The 1099K only talks about how many proceeds someone had. This is very distorting in terms of the results.
What Is The Likelihood Of An Audit If You Use Coinbase?
Anyone who's gotten a 1099K from Coinbase has probably said the reporting is outrageous and didn't make that much money.
I have a client right now going through an audit. They did not report the 1099K income from Coinbase on their 2018 return.
Coinbase's 1099K said that he had $3 million of income. And then he got an audit because he didn't report it.
It turns out he lost $17,000 cause while he might've had 3 million of income, you had $317,000 of cost basis. So he was in a losing situation.
It's a very misleading form, and the IRS has gotten a bit excited about them. Coinbase decided they're not issuing 1099 Ks this year because they're getting too much bad press.
The second form is a 1099MISC; this is used for reporting a lot of different things.
US exchanges will be reusing this form to report different types of income: non-trading income, for example, interest from staking, the value of airdrops that you might've received, and these different types of all of which is ordinary income.
There's another form called a 1099B for broker. This is the type of form you would get from like a brokerage house Merrill Lynch or Fidelity investors. And it's going to list what you bought the Google stock for what you sold the Google stock for.
I wish they would generate the same type of form for crypto because it's easy to take that form and plug it into your tax return.
As of right now, they're a long way away from having something like a 1099CRYPTO.
The reason is that the exchange that sells your coin has no idea what they bought it for. So no one who can report that creates a real complexity for you as the taxpayer.
It's easy to know what you sold the coin for, but for how much did I buy it?
For example, you bought one of those coins last month and also bought one of those coins last year at a lower price. Which one did you sell? Which one can you report selling?
You have to use a capital gains calculation service to work this out. If you try to do this by hand, after you've done like ten trades, your mind is going to be hurting. You'll be reaching for the alcohol.
I highly recommend Accointing because it does precisely this, and they've automated it to generate beautiful results.
Do You Need To Tick The Box On Your 1040 Return If You Have Crypto?
Over 75% of taxpayers have a “financial interest in virtual currency” as defined by the IRS.
The same definition the IRS is classifying for cryptocurrencies also classifies: frequent flyer miles, grocery store loyalty cards, and credit card reward points are all forms of a digital representation of a store of value.
These are all forms of virtual currency.
That means at least 75% of taxpayers should check Yes on the IRS virtual currency question.
Answering “No” when in fact, you do have a financial interest in cryptocurrency is perjury.
This question is designed to catch people trying to hide.
When you sign your tax return, you are swearing, “Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.”
Perjury is a felony and is punishable with prison.
Some traders who have not reported all their past crypto transactions are afraid that checking yes will encourage the IRS to review their past returns.
Based on my substantial experience with the IRS, this answer alone would not invite an audit.
The dangerous option is to answer “No.”
Failing to check “Yes” when you should have, exposes you to claims of filing a fraudulent tax return.
It would be grounds for losing your statute of limitations protection of three years on auditing a tax return.