You may have heard that cryptocurrencies are tax-free, but that doesn’t mean you don’t have to pay taxes on them. In fact, if you don’t, you could face some hefty penalties. So, do you have to pay taxes on crypto?
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The answer to the question posed in the title of this article is, unfortunately, that it depends on a number of factors and there is no one-size-fits-all answer. The reason for this is that, although cryptocurrency is a digital asset, it is still considered property for tax purposes in most jurisdictions. This means that whether or not you have to pay taxes on your crypto holdings will depend on how you acquired them and what you have done with them.
What is cryptocurrency?
Cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its biggest allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.
Cryptocurrencies are decentralized, meaning they are not subject to government or financial institution control. Bitcoin, the first and most well-known cryptocurrency, was created in 2009 by an anonymous individual or group known as Satoshi Nakamoto. Cryptocurrencies are created through a process called mining. Miners solve complex mathematical problems, and in return they are rewarded with cryptocurrency. Ethereum is the second most popular cryptocurrency after Bitcoin, and it was created in 2014 by Vitalik Buterin.
Over 4,000 types of cryptocurrency exist as of January 2020, and each operating on its own blockchain--a decentralized ledger that records all transactions. Common characteristics of cryptocurrencies include decentralization, limited supply, and anonymity. Some examples of cryptocurrencies include Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP).
What is a taxable event?
In the United States, the Internal Revenue Service (IRS) treats cryptocurrency as property. That means if you buy, sell, or trade cryptocurrency, you must pay taxes on any gains.
However, not every transaction is a taxable event. The IRS only considers a sale or trade of crypto to be a taxable event if you’ve made a profit. If you bought crypto and then sold it later for less than you paid, you don’t owe any taxes.
There are also some other exceptions to the rule. For example, if you give crypto as a gift or donate it to a charity, you don’t have to pay taxes on the transaction.
Finally, it’s important to note that even if a transaction is not a taxable event, you may still need to report it to the IRS. The agency has said that all crypto transactions must be reported on your tax return, even if they don’t result in a tax liability.
What if I don’t report my cryptocurrency?
If you don’t report your cryptocurrency, you may be subject to various penalties, including:
– civil penalties under the Tax Administration Act 1994; and/or
– criminal penalties under the Tax Crimes Act 1980; and/or
– interest and/or fines.
You may also have to pay tax on any unrealised capital gains if you later dispose of your cryptocurrency.
How do I pay taxes on cryptocurrency?
The Internal Revenue Service (IRS) has issued guidance on how to pay taxes on cryptocurrency. The guidance, which was released in 2014, states that cryptocurrency is to be treated as property for tax purposes. This means that any gains or losses from the sale or exchange of cryptocurrency must be reported on your tax return.
If you have bought and sold multiple times throughout the year, you will need to calculate your gain or loss for each transaction and report it on your return. You can use the average cost basis method to calculate your gain or loss. This method uses the average price of the cryptocurrency you acquired during the year to calculate your gain or loss.
If you have invested in a cryptocurrency mining operation, you will need to report the income you receive from the mining as ordinary income on your tax return. You will also be able to deduct any reasonable expenses incurred in connection with the mining operation, such as electricity costs.
If you have received cryptocurrency as payment for goods or services, you will need to include the fair market value of the cryptocurrency in your income. For example, if you were paid in Bitcoin for goods or services you provided, you would include the value of the Bitcoin in your income.
What if I don’t have enough money to pay my taxes?
If you do not have enough money to pay your taxes, you should contact the IRS immediately. The sooner you contact them, the better chance you have of reducing or eliminating your tax debt. There are a number of options available to taxpayers who cannot pay their taxes, and the IRS will work with you to find the best solution for your situation.
In short, yes, you have to pay taxes on your crypto earnings. The IRS has made it clear that they consider crypto to be property, and as such, any gains made from buying, selling, or trading crypto are subject to capital gains tax.
Of course, this only applies if you are making a profit; if you are selling crypto for less than you paid for it, then you can deduct your losses from other capital gains or income on your taxes.
Keep in mind that you will need to report any crypto activity on your taxes, even if you don’t ultimately owe any tax on it. So make sure to keep track of all your crypto transactions throughout the year so that you can accurately report them come tax time.