Crypto Taxes Explained
Table of Contents
Key Takeaways:
- Crypto taxes are an IRS tax that must be paid when an individual earns a profit through selling, trading, or disposing of cryptocurrency.
- Short-term capital gains are the income earned through selling crypto that was owned for less than 12 months and are taxed at the regular income tax rate corresponding to the taxpayer’s income tax bracket. Long-term capital gains are the profits earned through selling crypto that was owned for a period longer than 12 months and are taxed at a lower tax rate than short-term capital gains.
- Some examples of IRS taxable events that result in the taxpayer owing crypto taxes include selling cryptocurrency or other digital assets for cash, trading one type of cryptocurrency or digital asset for another, using cryptocurrency coins as a form of payment when making a purchase, staking or mining cryptocurrency, receiving cryptocurrency tokens via airdrop, accepting cryptocurrency as a form of payment for goods or services provided, and earning yield or interest through cryptocurrencies.
- Taxpayers must report crypto taxes to the IRS using IRS Form 8949 by providing details about the cryptocurrency transactions, such as the name of the cryptocurrency, the date the crypto was purchased or acquired, the date the crypto was traded, sold, or disposed of in another manner, the original cost of the crypto purchase, the value of the crypto at the time it was sold, and the total capital gain or loss from the crypto transaction.
What Are Crypto Taxes?
Crypto taxes are a type of IRS tax that is owed when a taxpayer sells, trades, or disposes of cryptocurrency in a way that results in them earning a profit on the exchange. Crypto taxes are reported to the IRS using IRS Form 8949, Sales and Other Dispositions of Capital Assets, an IRS document used to report capital gains and losses.
In the past when cryptocurrencies were first being developed, there was a level of confusion about how these digital assets were defined for tax purposes. Before the IRS expanded its definition of digital assets, many taxpayers neglected to report earnings through crypto transactions, claiming they were unaware of their requirement for reporting.
Even though cryptocurrency is still a comparably new form of digital asset that is becoming increasingly popular with investors, the IRS has recently introduced language into the instructions of IRS Form 1040, Individual Income Tax Return, that specifically asks taxpayers about their transactions with digital assets. This introduction is significant because taxpayers have less leniency about whether they are aware of their responsibility to report crypto taxes.
What Is Cryptocurrency?
The IRS considers crypto a type of “digital asset” that is treated as property as opposed to currency. If the digital asset has an equivalent value in real currency and can be substituted for real currency in transactions, such as cryptocurrency, this digital asset can also be referred to as a convertible virtual currency. The IRS’s definition of digital assets is as follows:
“Any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.”
Some examples of digital assets include cryptocurrency, convertible virtual currency, stablecoins, and non-fungible tokens (NFTs).
Cryptocurrency Vs. Fiat Currency
Both cryptocurrencies and fiat currencies can be utilized as a means of payment but the types are observed differently by the IRS. Cryptocurrency is a payment form that is created digitally and can exist outside of the assistance of a central bank. Fiat currency is a type of payment whose value is dependent on the decisions of central banks.
Capital Gains And Losses
Capital Gains
Taxpayers who sell a digital asset like cryptocurrency for more than what they initially purchased the asset for will owe capital gains tax on the profits to account for the increased value of the asset. There are different types of capital gains that are classified based on how long the taxpayer owned the asset before they sold or disposed of it: short-term and long-term.
Short-term capital gains are the income earned through selling crypto that was owned for less than 12 months. Short-term capital gains are reported alongside a taxpayer’s regular income for income tax purposes using the regular income tax rate corresponding to the taxpayer’s income tax bracket.
Long-term capital gains are the profits earned through selling crypto that was owned for a period longer than 12 months. The tax rate for long-term capital gains is typically lower than the tax rate for short-term capital gains, so taxpayers are rewarded with owing a smaller tax liability for cryptocurrency taxes when they hold onto the assets for longer.
Capital Losses
Capital losses describe situations in which a taxpayer sells cryptocurrency or another digital asset for less than what they initially paid for it. While this decrease in value has negative effects on the individual’s net worth, the upside is that they are able to deduct some of the loss from their taxes when they file their income tax returns.
Do Taxpayers Have To Report Crypto Gains And Crypto Losses?
It doesn’t matter if a taxpayer has experienced capital gains or capital losses with their crypto transactions – both of these categories must be reported to the IRS using IRS Form 8949.
When Do Taxpayers Owe Crypto Taxes?
Simply owning cryptocurrency does not necessarily mean that an individual will owe crypto taxes to the IRS when they file their federal income tax returns. Furthermore, there are certain cryptocurrency transactions that are considered taxable events while others are not considered taxable events.
What Is Considered Crypto Income?
Some examples of crypto activity that the IRS considers crypto income are:
- Mining crypto and claiming the associated rewards
- Staking crypto and claiming the associated rewards
- Accepting crypto as a method of payment for goods or services provided
- Lending crypto and earning interest payments
Taxable Cryptocurrency Transactions
In general, any time that a taxpayer sells, trades, or uses cryptocurrency to pay for something, this is considered the disposal of digital assets that could result in a capital gain or loss. The capital gain or loss through selling crypto is dependent on the cost basis, which is the amount they purchased the asset for, including any fees or commissions, as well as the value of the asset when it is sold.
Here are some crypto activities that are considered taxable by the IRS:
- Selling cryptocurrency or other digital assets for cash
- Trading one type of cryptocurrency or digital asset for another
- Using cryptocurrency coins as a form of payment when making a purchase
- Staking or mining cryptocurrency
- Receiving cryptocurrency tokens via airdrop
- Accepting cryptocurrency as a form of payment for goods or services provided
- Earning yield or interest through cryptocurrencies
Non-Taxable Cryptocurrency Transactions
Here are some examples of crypto exchanges that are not considered taxable events by the IRS:
- Using cash to purchase digital assets
- Transferring crypto or digital assets between accounts or crypto wallets that are controlled by the same person
- Donating cryptocurrency to charity through an event that is tax deductible
- Giving away cryptocurrency as a gift
2023 Cryptocurrency Tax Rates
While the tax rates for the profits earned through selling cryptocurrency are always related to the taxpayer’s annual income and filing status, there are also different tax rate classifications depending on how long the taxpayer holds the crypto assets before they sell.
Long-Term Crypto Tax Rates 2023
Single Filing
0% Tax Rate: $0 to $44,625
15% Tax Rate: $44,626 to $492,300
20% Tax Rate: $492,301 and above
Head Of Household Filing
0% Tax Rate: $0 to $59,750
15% Tax Rate: $59,751 to $523,050
20% Tax Rate: $523,051 and above
Married Filing Jointly
0% Tax Rate: $0 to $89,250
15% Tax Rate: $89,251 to $553,850
20% Tax Rate: $553,851 and above
Short-Term Crypto Tax Rates 2023
Single Filing
10% Tax Rate: $0 to $11,000
12% Tax Rate: $11,001 to $44,725
22% Tax Rate: $44,726 to $95,375
24% Tax Rate: $95,376 to $182,100
32% Tax Rate: $182,101 to $231,250
35% Tax Rate: $231,251 to $578,125
37% Tax Rate: $578,126 and above
Head Of Household Filing
10% Tax Rate: $0 to $15,700
12% Tax Rate: $15,701 to $59,850
22% Tax Rate: $59,851 to $95,350
24% Tax Rate: $95,351 to $182,100
32% Tax Rate: $182,101 to $231,250
35% Tax Rate: $231,251 to $578,100
37% Tax Rate: $578,101 and above
Married Filing Jointly
10% Tax Rate: $0 to $22,000
12% Tax Rate: $22,001 to $89,450
22% Tax Rate: $89,451 to $190,750
24% Tax Rate: $190,751 to $364,200
32% Tax Rate: $364,201to $462,500
35% Tax Rate: $462,501 to $693,750
37% Tax Rate: $693,751 and above
Cryptocurrency Tax Forms
There are several tax forms that are used in the process of reporting crypto exchanges to the IRS.
IRS Form 1040
IRS Form 1040, Individual Income Tax Return, is the standard tax form used to file income taxes every year during the tax season. Within this form, there is a section asking about the total gains or losses from digital asset transactions. The section reads as follows:
“At any time during 2022 did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
IRS Form 8949
IRS Form 8949, Sales and Other Dispositions of Capital Assets is a tax form used to report capital gains and losses from transactions related to investments. This tax form is separated into two sections with different functions. Part I of IRS Form 8949 is where taxpayers must report their short-term capital gains and losses, and Part II of IRS Form 8949 is used to report long-term capital gains and losses.
Short-term capital gains and losses are reported in a different section of the tax form than long-term capital gains and losses because they are taxed at different tax rates. Short-term capital gains and losses are the same as income tax rates for the individual’s tax bracket, whereas long-term capital gains and losses are taxed at a different capital gains rate.
IRS Form 1099-MISC
IRS Form 1099-MISC is a tax form that is used to report ordinary income to the IRS that was not earned through a salaried or wage job that reports income using a W-2 tax form. The income reported on 1099 forms is taxed in correspondence with the individual’s personal income tax bracket.
Many types of income can be reported using IRS 1099-MISC forms, including cryptocurrency earnings, staking, mining, yield generation, referral bonuses, hard forks, and more.
If a cryptocurrency platform paid an individual $600 or more during the year in cryptocurrency earnings, they will likely send out a 1099-MISC form to the taxpayer as a record of their crypto exchanges. Taxpayers who receive a 1099-MISC form can then use this information when filling out their federal income tax return.
IRS Form 1099-B
IRS Form 1099-B, Proceeds from Broker and Barter Exchange Transactions is another IRS tax form that is used to report the disposal of capital assets through a brokerage. Due to cryptocurrencies being a newer type of digital asset, however, cryptocurrency exchanges are not required by the IRS to provide 1099-B forms to customers the same way that traditional brokerages do.
Due to a law that was passed by Congress in 2021, digital asset brokers will soon be required to report capital gains and losses from their clients using either IRS Form 1099-B or a different type of 1099 form, 1099-DA. This law will make it much easier for taxpayers and digital asset brokerages alike to report crypto taxes to the IRS because there will be clear documentation shared between the parties identifying their capital gains and losses.
IRS Form 1099-DA (Expected 2024)
IRS Form 1099-DA, Digital Asset Proceeds from Broker Transactions, is a new tax form that is used to report the proceeds of digital asset transactions. Broker exchanges will be responsible for providing the 1099-DA tax form to the IRS and to the clients who experienced crypto transactions using their platform. Within this tax form, the digital asset brokerage will have to report both the original cost basis and the customers’ transfers for both broker-to-broker and broker-to-non-broker transfers.
How To Calculate Crypto Capital Gains Taxes
Here are the steps for calculating the capital gains earned from crypto transactions:
1. Calculate the initial cost basis.
The cost basis of an asset such as cryptocurrency includes the total sum of the purchase price of the asset along with any additional fees or commissions they paid. Essentially, the cost basis is the initial price of the asset when the taxpayer acquires it.
2. Determine the realized amount.
The realized amount of cryptocurrency is the value that the capital asset was sold for.
3. Subtract the cost basis from the realized amount.
Subtracting the cost basis from the realized amount will reveal whether the cryptocurrency experienced a capital gain or a capital loss. If the realized amount was a greater value than the initial cost basis, the taxpayer will owe capital gains taxes on the profit. If the capital asset was sold for less than what they initially paid, they can deduct some of the capital loss from their taxes.
4. Calculate the capital gains using a 2023 tax rates guide.
After calculating the difference between the cost basis and the realized amount, taxpayers can use a capital gains rate chart to determine how much crypto tax they owe. To do so, they will need to identify whether the event is classified as a short-term or long-term capital gain and apply this tax rate to each cryptocurrency transaction.
How To Report Crypto Taxes To The IRS
Taxpayers must report their cryptocurrency gains and losses by filing IRS Form 8949 with the IRS.
Information Needed To Report Crypto Taxes
In order to successfully complete IRS Form 8949 to report crypto taxes to the IRS, individuals must gather the following information regarding their cryptocurrency transactions:
- The name of the cryptocurrency
- The date the cryptocurrency was purchased or acquired
- The date the cryptocurrency was traded, sold, or disposed of in another manner
- The cost basis, or original cost of the cryptocurrency purchase
- The realized amount, or the value of the cryptocurrency at the time it was sold
- The total capital gain or loss from the crypto transaction
The taxpayer must provide this information for every taxable cryptocurrency transaction for the tax year they are filing taxes for. Due to the detailed requirements, it is beneficial for individuals to prepare for cryptocurrency tax reporting by maintaining diligent records related to all aspects of crypto events.
Tips For Minimizing Crypto Taxes
There are several strategies taxpayers can employ so that they can minimize what they owe in crypto taxes when it is time to file their federal income tax returns.
Hold onto digital currencies for longer than 1 year
Holding onto crypto investments for 12 months or longer will qualify the capital gains o
n the asset to be taxed at the long-term capital gains tax rate, which is usually the lowest possible tax rate, instead of the tax rate of their regular income tax bracket.
Offset capital gains with capital losses
Cryptocurrency is taxed in a similar manner to other types of investments in that taxpayers have the opportunity to write off capital losses on other investments. The maximum amount of money that can be deducted as a capital loss is $3,000 for each tax year. This process is called tax-loss harvesting.
Charitable donations
Donating some of the profits earned from cryptocurrency investments to an eligible charity is another strategy for someone to reduce their crypto tax liability. This process works by allowing the taxpayer to deduct an amount worth the fair market value of the crypto when it is donated.
Retirement accounts
Another strategy for minimizing capital gains tax liability for cryptocurrencies is to use a retirement plan such as a Roth individual retirement account (IRA) or a traditional IRA to invest in crypto to defer or avoid investment gains. While this strategy has benefits, it is important to note that this investment process is more complicated than investing through a normal brokerage exchange.
Deduct crypto mining expenses
Cryptocurrency investors may conduct their mining activities from home without consciously spending money on mining materials, but there are costs related to mining cryptocurrency that can be deducted from their taxable income to lower their tax liabilities. Some examples of expenses that could be deducted from their mining income include computers, electricity, servers, and internet service provider charges.
Frequently Asked Questions
Do I owe crypto taxes for the digital assets I’m holding?
Taxpayers are only required to pay crypto taxes for digital assets that are realized, claimed, or sold. This means that they will not owe crypto taxes for simply owning cryptocurrency, but they may owe capital gains taxes if they sell their cryptocurrency for more than what they initially purchased it for.
What are some common examples of cryptocurrencies?
- Bitcoin
- Bitcoin Cash
- Bitcoin Gold
- Litecoin
- Ethereum
- Cardano
- Ripple Chain
- Stellar Lumens
- VeChain
- Monero
- EOS
- Neo
- Zcash
- Qtum
- Iota
- Tron
- Dash
- Lisk
- Tether
- NEM
- OmiseGO
Are there penalties for failing to report cryptocurrency to the IRS?
The IRS requires taxpayers who undergo taxable crypto events to report that information when they file their taxes, so neglecting to do so can lead to consequences with the IRS. It is possible that the individual will owe interest on the unpaid taxes or they may be issued tax penalties. Furthermore, if they are subjected to an IRS audit, it is possible to face criminal charges for failing to report crypto taxes, failing to pay crypto taxes, or making an error in their tax reporting.
Do I have to file crypto taxes if I don’t receive a 1099 form?
Taxpayers are required to file crypto taxes with the IRS when they have been involved in crypto-related taxable events regardless of whether or not they received a 1099 tax form from a brokerage detailing their crypto exchanges. It is the taxpayer’s responsibility to keep a record of their cryptocurrency transactions so that they can accurately report this information to the IRS.
What happens if I inherit cryptocurrency?
The IRS treats the inheritance of cryptocurrency the same as if another type of capital asset was passed down from one person to another. If you have inherited cryptocurrency from someone, it is beneficial to keep in mind that, depending on the value of the asset that is passed down, if it exceeds the threshold of $12.92 million, it may be subject to estate taxes.
Understanding your requirements for paying crypto taxes is an essential aspect of being a digital asset investor, and if you have any confusion about the tax filing process when reporting crypto transactions, it is always beneficial to get help from an experienced tax professional. Schedule a free consultation with the experts at Ideal Tax today to find the answers to your questions about crypto taxes or any other tax matter and feel confident that you are optimizing your tax savings.
Luis serves as the Director of Operations for Ideal Tax, overseeing a multifaceted team including case management, tax professionals, document specialists, customer support, training, and development.
