Updated: Jul 23
Cryptocurrency is quickly becoming one of the world's most valuable financial assets. With millions of Americans dabbling into cryptocurrencies and the success it has attracted globally within the short period it hits the financial space, tax authorities are eager to get their own share of the revenue from activities like crypto mining, trading, and even income earned from airdrops, forks, and decentralized finance platforms.
Whether you're an experienced crypto trader or investor, or you are new in the game, you need to pay the appropriate taxes and report your income to the tax authorities. Crypto tax returns can be overwhelming, so it's important to understand how cryptocurrencies are taxed and how to file your cryptocurrency taxes.
In this post, you will learn everything you need to know about crypto taxation and also
understand how to reduce your crypto tax bill.
Let's dive in.
How Is Cryptocurrency Taxed?
Cryptocurrency is subject to ordinary income and capital gains tax in the United States. Let's explain how ordinary income and capital gains tax work:
Ordinary income tax
Income earned from crypto-related activity is subject to ordinary income tax. Examples include income from crypto staking, airdrops, mining rewards, and referral bonus. The tax payable is based on the ordinary income tax rates at the time of receipt.
Capital gains tax
A capital gain tax is incurred when you dispose of cryptocurrencies. Disposing of your
cryptocurrencies means selling, trading, swapping for other coins, or when you use your
cryptocurrencies to make a purchase. For example, let's say you bought $100 worth of Bitcoin in January and you sell the asset for $200 in March, you automatically incur a $100 capital gain tax.
If you dispose of your crypto assets in less than 12 months, your capital gain will be taxed at the rate of 10-37%. Capital gains made after 12 months of disposing of your cryptocurrencies are taxed at the long-term capital gains rate of 0-20%.
Remember, you don’t pay one flat tax rate on all of your taxable income. Instead, you’ll pay
progressively higher tax rates on each portion of your income. For example, if you make a total of $25,000 for the year, the IRS doesn't expect you to pay a flat tax rate of 12% on the earned $25,000. Instead, you pay different tax rates as you ascend through the income tax brackets. And in this case, you'd pay 10% on the first $10,275 and 12% on the next $14,725.
Can you treat an airdrop as a zero-cost basis transaction?
For airdrops or forks, you need to consider the Fair Market Value (FMV) of the assets at the
time you received it. BCH, BTCSV, and ETC are some airdrops/forks that have a market value. You may consider the market value as $0.00 for airdrops without fair market value.
How Do I Keep Track of My Transactions for Tax Purposes?
You can keep track of your transactions for tax purposes by keeping a recording of the following information when you are involved in a crypto transaction:
● The cost of purchasing your cryptocurrencies
● The date you acquired the cryptocurrencies.
● The type of cryptocurrencies you acquired
● The type of cryptocurrencies you disposed of.
● The date you disposed of your cryptocurrencies
● The amount you disposed of the cryptos.
● Relevant fees
The above information will help you file your crypto taxes appropriately. Of course, keeping
track of all your crypto transactions to calculate crypto profits/losses can be pretty difficult,
especially if you have accounts on different exchanges. Using a crypto profit/loss calculator can help out in this regard. The calculator will automatically import your transactions from all the exchanges you have an account.
How Do I File My Cryptocurrency Taxes?
If you're in the United States, you can file your capital gain tax using Form 8949. Unlike capital gains, ordinary income doesn't fall onto one tax form. Depending on your specific situation, you need different tax forms to file tax returns for the income you received from mining, staking, worker's compensation, or interest accounts.
Here are the forms you will need to file crypto tax returns for ordinary income:
● Schedule C: Cryptocurrencies received as a payment for contract work, operating a
node, or running a cryptocurrency mining operation are reported on Schedule C. This
income is treated as self-employed income. With Schedule C, you can also calculate or
deduct business expenses such as electricity used for mining to offset your business
● Schedule B: Income earned through staking or interest rewards is generally reported on
● Schedule 1: Income earned from airdrops, forks, or other crypto hobby incomes are
reported on Schedule 1 as other income.
If you're not in the US, you need to check with the tax authorities in your region for tax filing
What happens if you don’t report your crypto taxes?
The IRS considers tax evasion as fraud. And when you intentionally commit fraud, the IRS
can enforce a number of penalties, including a fine, imprisonment, or criminal prosecution.
But what if you genuinely forget to report your crypto taxes? Don't worry. You can always
amend a prior year's tax return to include your crypto-related income with IRS Form 1040. It's better to amend a prior year's tax return to include your crypto-related income than wait for the IRS to find you. Filing accurate tax returns may not even trigger the IRS radar even if you amend a prior year's tax.
Can the IRS track your cryptocurrency?
Many taxpayers believe that since cryptocurrencies are anonymous the tax authorities will find it very difficult to track. This is far from the truth. Remember, all transactions that occur on the blockchain are permanent and publicly visible. The IRS, for instance, can determine your crypto activities through 1099 reports, subpoenas, and Schedule 1.
Major exchanges like Coinbase now send 1099 forms to the IRS, which contain the records of your crypto income. The IRS can use this information to track down your cryptocurrency
activities if you evade taxes. The tax authority has in the past partnered with contractors like
Chainalysis to analyze the blockchain and crack down on tax fraud.
Cryptocurrency tax returns are usually a challenge for most investors and traders. You owe
taxes on your cryptocurrencies when you earn or dispose of cryptos. And you need to report these taxable events to the appropriate tax authorities.
While you cannot evade crypto taxes, there are strategies you can deploy to reduce your tax bill, including holding your cryptocurrencies in an IRA, harvesting your losses, and realizing profits in low-income years.
Tracking your cryptocurrency transactions and reporting your taxes accurately will save you
thousands of dollars during tax season.