June 23, 2021
Cryptocurrency has become all the rage in the investment community, but it carries with it significant tax liabilities that anyone who already does or soon wants to invest should keep in mind.
There’s an ever-growing list of cryptocurrencies available to trade. The most prominent is called Bitcoin, though others, like Dogecoin, Ethereum, and Cardano are also popular and regularly traded. Additionally, lesser-known cryptocurrencies that trade on alternatives to popular apps like Coinbase and Robinhood are also available.
Regardless of the cryptocurrency you decide to trade and whether you buy and sell cryptocurrency on popular or lesser-known marketplaces, there are tax implications when you take a gain or loss on your investment. Indeed, while cryptocurrency is a relatively new way for people to invest, its tax treatment reflects older styles of investing.
So, how are cryptocurrency investments handled for tax purposes? If you invest in cryptocurrency at one price but ultimately sell at a higher price, you face a capital gain and therefore, a tax on that gain. Similarly, if you sell your cryptocurrency for less than you bought it for, the IRS allows you to take a capital loss and reduce your taxes.
There had been some debate over whether cryptocurrency investments should be made taxable at capital gains rates or standard income tax rates. The IRS ultimately decided, however, that capital gains taxes would be best way to accurately tax cryptocurrency investments.
Of course, when dealing with capital gains taxes, rates vary depending on whether you’re incurring a short-term or long-term capital gain. Any time you sell a cryptocurrency investment within one year of buying it, you will face a short-term capital gain (again, if you sold it for more than you bought it for). If you hold on to the investment for longer than one year, you’ll be subject to a long-term capital gain tax.
It’s also worth noting that if you buy goods or services with cryptocurrency that has appreciated in value, you will need to pay capital gains tax on the increase in value. However, if you use cryptocurrency that has depreciated in value on the purchase of goods or services, the IRS does not allow that loss in value to be deductible if you acquired the goods or services for personal use.
Short-term capital gains follow tax brackets and will vary depending on your income. Long-term capital gains tax rates are fixed across three tiers depending on your income.
Here’s a breakdown of current-year capital gain tax rates:
Short-Term Capital Gains Tax Rates
10%: Income of between $0 and $19,900 for Married Filing Jointly ($0 and $9,950 for single filers)
12%: Income of between $19,901 and $81,050 for Married Filing Jointly ($9,951 and $40,525 for single filers)
22%: Income of between $81,051 and $172,750 for Married Filing Jointly ($40,526 and $86,375 for single filers)
24%: Income of between $172,751 and $329,850 for Married Filing Jointly ($86,376 and $164,925 for single filers)
32%: Income of between $329,851 and $418,850 for Married Filing Jointly ($164,926 and $209,425 for single filers)
35%: Income of between $418,851 and $628,300 for Married Filing Jointly ($209,426 and $523,600 for single filers)
37%: Income of $628,301 and above for Married Filing Jointly ($523,601 and above for single filers)
Long-Term Capital Gains Tax Rates
0%: Income between 0 and $80,800 for Married Filing Jointly ($0 and $40,400 for single filers)
15%: Income between $80,801 and $501,600 for Married Filing Jointly ($40,401 and $445,850 for single filers)
20%: Income including and above $501,601 for Married Filing Jointly ($445,851 and above for single filers)
Although most cryptocurrency transactions will fall into the capital gains tax, there are a limited number of cases when transactions are instead taxable income. Here’s a breakdown of those events:
Receiving a cryptocurrency payment in exchange for carrying out tasks or performing a job
Earning cryptocurrency from liquidity pools
Earning cryptocurrency by cryptomining transaction fees
Earning cryptocurrency from DeFi lending
Receiving cryptocurrency in an “airdrop” designed to market a new currency
How Does the IRS Know?
With such complexity surrounding cryptocurrency, you may be wondering how the IRS even discovers that you’ve been trading the digital asset.
In 2019, the IRS sent demand and action letters to thousands of cryptocurrency investors informing them that they may have not reported or inaccurately reported cryptocurrency gains to the IRS and may face an additional tax and penalty.
Since then, popular trading platforms like Coinbase have issued 1099 forms to investors and the IRS, informing them of their taxable events from the past tax year.
However, in a move that has angered some investors, many of those trading platforms use form 1099-K instead of the standard 1099-B that investment banks use for stock and bond transactions. The cryptocurrency trading services have said that the 1099-K allows for easier reporting, but it also lacks cost basis, making the calculation of any tax due even more difficult to determine.
Looking ahead, the IRS is expected to compel cryptocurrency trading services to use the standard 1099-B form, though if and when that actually happens is unknown.
Needless to say, there’s plenty to think about and consider as it relates to your cryptocurrency transactions. If you already invest or plan to invest in cryptocurrency, we urge you to reach out to your Perlson LLP professional at 516-541-0022 for tax advice and assistance in helping you navigate cryptocurrency regulations.