Cryptocurrencies usually referred to as virtual currencies, have been widely accepted. Using bitcoins, on the other hand, has federal income tax ramifications. If you made crypto transactions last year, here’s what you’ll need to know before filing your taxes in 2021.
In the United States, cryptocurrencies are classified as property for federal income tax purposes, and investors must pay a specific amount of capital gains tax when they sell their crypto.
Unlike the stock market, where investors can buy, sell, and trade various equities through a single brokerage, crypto investors are more likely to trade on multiple exchanges and utilize various wallets.
While stock traders receive a single Form 1099-B from their broker, with crypto, “it is the users’ job to connect all the exchanges and wallets into one spot, to record and calculate out the taxes for that year,” according to the website.
Accounting for cryptocurrency in your tax return is pretty simple for most people who buy and trade it on internet exchanges. However, like with most things linked to digital currency, things can become more convoluted as you become more involved.
According to IRS instructions on your Form 1040 tax return, if your only crypto-related action this year was purchasing a virtual currency with US dollars, you don’t have to report it to the IRS.
The IRS Form 1040 for 2021 asks if you received, sold, swapped, or otherwise disposed of any financial interest in any virtual currency during the year. You must select “Yes” from the drop-down menu if you did. The IRS is serious about ensuring compliance with the applicable tax rules, as evidenced by the fact that this question appears on page 1 of Form 1040, right below the lines for providing basic information like your name and address.
A taxable transaction occurs when you sell an investment or exchange it for another investment. If you conduct a lot of trading, you must exercise caution. Every time you trade-in and out of different types of cryptocurrencies, it is taxable.
Because virtual currencies are considered property by the IRS, their taxable value is determined by capital gains or losses – in other words, how much value your assets gained or lost over time.
Because you’re spending a capital asset to get anything or receive another asset, when you exchange cryptocurrencies or use bitcoin to buy something, those transactions are subject to capital gains taxes.
The capital gain or loss — what you’ll declare on your tax return — is the difference between the amount you spent when you bought or got the cryptocurrency (its cost basis) and the amount you earn when you sell it.
The length of time you’ve had the cryptocurrency is also a factor. A long-term capital gain would be considered if you held onto a unit of Bitcoin for more than a year. It’s a short-term gain if you acquired and sold it within a year. These distinctions may have an impact on the tax rate that is applied. The tax rate varies depending on your total taxable income, and you can only deduct a certain amount in capital losses if your crypto asset loses value.
You can reconcile your capital gains and losses on Form 8949 and then report them on Schedule D of your Form 1040 tax return. Additional information and tools are available on the IRS website to assist you in determining your crypto-related tax burden and reporting it.
Bitcoin used to pay for services.
If you pay employees using Bitcoin, you must file W-2 forms with the IRS to disclose their earnings. You must translate the value of Bitcoin to US dollars on the date each payment is made and keep meticulous records. Wages paid in virtual currency are subject to withholding as wages paid in dollars.
Even if paid in Bitcoin, employees must record their overall W-2 wages in dollars. Self-employed people who receive Bitcoin as a form of payment must convert the virtual currency to dollars on the day they receive it and disclose the results on their tax returns.
What about NFTs?
Trading NFTs may result in taxable events. Consider an investor who purchases an NFT: they most likely used their funds to purchase another cryptocurrency, which they then used to purchase the NFT. They had a prospective cash gain or loss, which they may not have realized.
Meanwhile, when a creator sells an NFT on a marketplace, their gains are taxed.
Even if investors do not withdraw cryptocurrencies from their wallets and convert them to fiat currency, the IRS could discover crypto transactions in various ways.
When it comes to criminal activity, the IRS may employ blockchain analytics technologies to link pseudonymous wallets to real people participating in illegal operations.
You don’t have to do the process all by yourself, contact us for more information.