The dreaded tax season is approaching fast for cryptocurrency traders and investors in the United States. Filing taxes is already a stressful process, and adding cryptocurrencies to the mix only serves to amplify that, especially with so much uncertainty on the matter.
This article is not meant to be financial advice, and you should still seek personalized tax advice if you are unsure about the proper actions to take. That said, hopefully the information and resources in this article will help point you in the right direction, significantly reducing the amount of time you need to spend researching on your own.
Cryptocurrency is Considered Property
The most relevant document when it comes to paying US federal taxes on your cryptocurrency transactions is Notice 2014-21. Unfortunately, this notice does not establish any clear and straightforward answers on exactly how to pay taxes. Rather, it attempts to fit cryptocurrencies into previously existing general tax principles.
In tax code, cryptocurrency is referred to as “convertible virtual currency.” The word “convertible” expresses the idea that virtual currencies, like Bitcoin, can be exchanged for legal tender like US dollars. As such, all virtual currency is treated like property for general tax purposes.
As a result of being considered property, all cryptocurrency exchanges are considered taxable events. This means that buying a cup of coffee with Bitcoin is a taxable event, as is exchanging Bitcoin for Ethereum or US dollars on an exchange.
However, it’s important to make the distinction between exchanges and transactions, because not all transactions are taxable events. The ones that aren’t taxable are those in which you send cryptocurrency from one wallet to another but you own both wallets. It’s the equivalent of moving money from your checking account to your savings account. No exchange takes place in those transactions, so they are not taxable.
Likewise, simply buying and holding cryptocurrency is not taxable. If you do not sell or exchange any cryptocurrencies in a given year, you do not owe any taxes on what you are holding.
Capital Gains and Losses
Being considered property, virtual currency is taxed very similarly to stocks and bonds. That means that you will pay capital gains or deduct capital losses on every taxable event.
There are four critical pieces of information you should know in order to pay or deduct the correct amount:
- The date that you first acquired the virtual currency
- The price at which you bought or otherwise acquired it, (including the transaction/deposit fee)
- The date that you sold or exchanged the virtual currency
- The price at which you sold or exchanged it (reduced by the transaction/withdrawal fee)
Several exchange platforms offer some type of tax report based on your account activity. If you haven’t tracked all of your exchanges yourself, you’ll want to look for these reports. For future reference, though, it’s always best practice to do your own record keeping. Perhaps that’s easier said than done if you are an active trader, but it beats having the IRS come after you because the exchange you used went under or somehow screwed up your report. Better safe than sorry.
If you don’t have experience with capital gains and losses from other investments, information about how to calculate what you owe is easy to find. Capital gains are categorized as either long-term (usually greater than 1 year) or short-term. Short-term capital gains are taxed the same as income, so the rate will depend on which tax bracket you fall into. Long-term capital gains are taxed at a lower rate, also dependent on income as shown in the table below.
Capital gains or losses are simply the change in value from the time you buy an asset to the time you sell it. For example, if you buy 1 Bitcoin at $10,000 and sell it one week later for $11,000, you pay taxes on the $1,000 gain only.
If you lost money on an investment, it’s possible you can deduct that on your taxes. Losses can be categorized one of three ways: theft loss, casualty loss, or capital loss. If you were hacked, lost your hard drive, etc., you may be able to deduct those events as casualty or theft losses.
It should be noted that the maximum deduction for property losses in a single year is just $3,000. Additionally, you cannot calculate casualty losses based on the price of the asset at the time of the loss. Rather, the loss is calculated based on the price of the asset when you purchased or otherwise acquired it.
With the Tax Cuts and Jobs Act taking effect in 2018, deductions for casualty losses will no longer be possible for property assets that are not real estate. If you lost a hard drive with Bitcoin on it, this is the year to claim that loss on your tax report.
One other point to clarify is what to do with a specific virtual currency that you’ve bought on multiple occasions. For instance, suppose that you bought 0.1 Bitcoin every week for 10 weeks until you had 1 full BTC. Each time you bought, it was likely at a different price. Now, when you decide to sell 0.1 BTC, you have to calculate the gain or loss based on one of the 10 prices at which you bought.
This isn’t explicitly covered in Notice 2014-21 or elsewhere. However, the common practice with other property assets is first-in-first-out (FIFO). In other words, you would calculate your loss or gain for the 0.1 BTC you are selling based on the first 0.1 BTC that you bought.
Of course, there may be times when you can save money by doing something besides FIFO. There is nothing in the current legislation saying that you can’t do this, but it’s possible for future legislation to mandate FIFO retroactively. Should this happen and you calculated the tax owed for your crypto assets another way, you may have to go back and redo previous tax returns. However, for some people, it will likely be worth the risk to do last-in-first-out (LIFO) instead.
One way that FIFO can really come in handy is with long-term capital gains. For example, if you started buying Bitcoin consistently in 2015 and didn’t sell any of it until 2017, it would make sense to apply FIFO to your sales so that you pay long-term capital gains tax instead of short-term.
To the contrary, LIFO can really come in handy if you use a buying strategy like dollar cost averaging during a bull market. For example, imagine that you started regularly buying 1 ETH per month, starting on January 1, 2017. (Hopefully you don’t have to imagine!) Now suppose that you decided to take some profit for the first time in November when the price nearly passed $500.
In this case, LIFO would drastically reduce the amount of gains you have to pay taxes on for the proportion of your holdings that you sell. If you calculated the gains based on the price you bought on November 1, you’d owe taxes on about $160 in capital gains. If, instead, you used FIFO, you would owe on about $470 in capital gains.
With the incredible price volatility in cryptocurrency, your choice between LIFO and FIFO can make a big difference. The decision is ultimately up to you. If LIFO allows you to pay significantly less, it makes sense to go with it and take your chances with the IRS applying a FIFO standard retroactively.
Mining and Getting Paid in Cryptocurrency
If you mine cryptocurrencies or get paid with them, that is treated simply as income and taxed in the same way that it would be if it was a conventional income paid in US dollars. If you choose not to immediately sell whatever you’ve earned, you must still pay income tax on the original amount. Whatever loss or gain that you experience after that is taxed as described in the sections above.
Hard forks and airdrops are two events in the cryptocurrency world that are ambiguous when it comes to taxes. For anybody who doesn’t know, an airdrop is an event in which a blockchain project distributes free tokens or coins to the community. This is a very successful marketing tactic and has been employed by well-known projects including Stellar Lumens and OmiseGo.
People who receive airdrops do so knowingly, so there’s no chance of playing the ignorance card in this case. As such, the safest way to treat airdrops is simply as you would income that gets paid in cryptocurrency. Whether you sell immediately or hold onto your free coins, you should plan to pay income taxes on the original amount you received.
As for hard forks, pleading ignorance is far more plausible. There have been more than a dozen Bitcoin hard forks since fall of 2017 alone. It would be hard for anybody to keep track of them all, let alone the average investor who might not even know what hard forks are. Taking that into account, treating hard forks as income and expecting all holders to account for all hard forks would be ridiculous.
What makes better sense is to simply assign a cost basis of zero to any forked coin that you receive. In other words, treat the forked coin as if you bought it the day of the fork. If it’s worth $30 the day that you received it and you sell at $40, the only taxable event is the sale with a capital gain of $10.
Other Helpful Resources
For an in-depth discussion of the topics touched on in this article, you can check out the January 23, 2018 episode of the Unchained podcast. It’s an approximately 1-hour long episode in which host Laura Shin talks to tax attorney, Tyson Cross, and CPA, Jason Tyra. They cover additional topics, including the risks of treating crypto-to-crypto exchanges as like-kind exchanges and deferring paying taxes on them.
Additionally, there are a few services that offer portfolio tracking and tax reports to reduce some of your workload, especially if you have carried out more than a handful of exchanges. The most popular and trusted of those services are https://bitcoin.tax/ and https://cointracking.info/.
After the incredible bull market of 2017, it’s likely that capital gains taxes will be pretty steep for many of you reading this. However tempting it may be to just avoid this mess and keep your cryptocurrency portfolio off your tax filing, it’s certainly not wise to do so. We’ve already seen the IRS demand extensive records from Coinbase last year, and we know that new regulations are imminent.
Tax day is April 17 this year in the US. Stay ahead of the game and file your taxes with all virtual currency exchanges included to the best of your ability. Better a little headache now than steep penalties for tax evasion and a bigger headache somewhere down the line.
The Republican Party can’t live on the dollars of libertarian billionaires and the votes of downwardly mobile white reactionaries alone. Without the support of culturally moderate, but fiscally self-interested suburban homeowners, the GOP’s congressional majorities would cease to exist. Highly educated, highly affluent blue-state suburbs put the Speaker’s gavel in Paul Ryan’s hand — and he then used it to pare back one of their favorite tax deductions.
There’s been a lively debate in recent days about whether the GOP’s deeply unpopular tax bill will become more — or less — politically toxic between now and the 2018 midterms. Pessimistic progressives contend that once voters realize the legislation reduces their short-term tax burden, they’ll view it more fondly. Others argue that the stench of corruption that clings to the bill will prove more potent than its meager middle-class benefits.
Well-off homeowners across the country spent the past week fighting for their tax planners’ attentions; waiting in long lines to prepay their 2018 property taxes, in hopes of getting in one last, unlimited deduction before the new rules take effect — then learning that those prepaid taxes might not actually be deductible, anyway.
Furthermore, the IRS’s guidance doesn’t define “assessed” — an oversight that’s proven confounding for New Jersey residents. As Bloomberg explains:
By state law, a New Jersey property assessor “shall determine his taxable valuations of real property as of October 1 in each year” – language that sounds promising for would-be tax cutters. But the same statute holds that the assessor “shall complete the preparation of his assessment list by January 10.” Ultimately, the “final assessment” is to be completed by May 5.
President Trump signed the “Tax Cuts and Jobs Act” into law, and it makes major changes to the U.S. tax code for both individuals and corporations. Yahoo News states, the bill represents the most significant tax changes in the United States in more than 30 years.
With the that in mind, here’s a guide to all of the changes that will go into effect — the new tax brackets, modified deductions and credits, corporate tax changes, and more.
The 2018 tax brackets
The final bill kept a seven-bracket structure but with mostly lower tax rates.
The marriage penalty is (almost) eliminated
The marriage penalty has been effectively eliminated for everyone except married couples earning more than $400,000.
Standard deduction and personal exemption
The standard deduction has roughly doubled for all filers, but the valuable personal exemption has been eliminated.
Capital gains taxes
Short-term gains are likely taxed at a different rate than they formerly were. In addition, the three capital gains income thresholds don’t match up perfectly with the tax brackets.
Different groups have weighed in on the cost and impact of the various versions of the tax plans and bills. Here are some of the major players listed in the Marketplace.
Congressional Budget Office: The CBO is the greatest ally and enemy of members of Congress trying to push legislation. The agency “scores” legislation to determine how much a bill will cost the government and how it will affect Americans. When those scores don’t line up with what someone wants to hear, the agency is often labeled as biased. The director of the CBO is appointed by House and Senate leadership, and the current director, Keith Hall, was appointed by Republicans.
Joint Committee on Taxation: This committee helps members of the House and Senate with research on tax-related matters. Its primary function is to provide reports to members of Congress, but some of its information is public. Often when you hear about reports from the JCT, members of Congress have leaked them to the media or think tanks, rather than them being available to the public.
Tax Foundation: The Tax Foundation is generally considered a right-leaning think tank and provides many detailed analyses of how the various tax plans could impact the economy. The group faced some criticism for the way it crunched the numbers on the House plan, and subsequently changed its model and issued a correction.
Tax Analysts: This is the nonprofit arm of a group that also runs Tax Notes, a tax-focused news outlet that sells newsletter subscriptions to individuals and businesses.
Attorney General Jeff Sessions announced that the Justice Department is settling class action lawsuits brought by more than 400 conservative groups who claim they were “improperly” delayed when seeking tax-exempt status with the Internal Revenue Service.
“There is no excuse for this conduct. Hundreds of organizations were affected by these actions, and they deserve an apology from the IRS. We hope that today’s settlement makes clear that this abuse of power will not be tolerated,” said Sessions.
As mentioned in NPR, the consent order says the IRS admits it wrongly used “heightened scrutiny and inordinate delays” and demanded unnecessary information as it reviewed applications for tax-exempt status. The order states, “For such treatment, the IRS expresses its sincere apology.”
The IRS stepped up its scrutiny around 2010, as applications for tax-exempt status surged. Tea Party groups were organizing, and court decisions had eased the rules for tax-exempt groups to participate in politics.
The U.S. Internal Revenue Service is exploring whether the Chronic Disease Fund, a patient-assistance charity funded largely by drugmakers, gave “impermissible” benefits to its corporate donors, according to federal court filings.
According to Bloomberg, an IRS analysis found that 95 percent of the $129.3 million the charity spent on co-payment support in its public programs in 2011 went to patients taking drugs made by the very companies that had donated the money, according to court papers.
Donations from drug companies “are nearly all returned to those same pharmaceutical manufacturers as payments for the drugs they make,” attorneys for the IRS said in papers filed in federal courts in California, Pennsylvania and other states, seeking information related to the probe. “In effect, CDF is serving as a conduit for its pharmaceutical manufacturer ‘donors,’” government lawyers said.
The IRS has sent summonses to Roche Holding AG’s Genentech unit, Biogen Inc., Johnson & Johnson, Teva Pharmaceutical Industries Ltd., Novartis AG and Bayer AG, seeking information on donations to CDF. Biogen, Novartis and Bayer said they’re cooperating with the IRS summonses, and Teva declined to comment. J&J said it has no control over how co-pay charities operate. Roche declined to comment on ongoing legal matters.
Getting audited is not something a business owner wants to go through. However, there is a slight chance that it might take place. So what happens if you get audited by the IRS?
Most people do not want to think about getting audited. Instead they focus on how to avoid an IRS audit altogether if possible. However, the IRS could randomly select you for an audit or, you could make errors on your IRS forms.
According to Patriot Software, only about 2.5% of small business owners get audited. But, understanding what happens if you get audited is an important part of being a business owner. If you are audited, you might have some questions:
- What information does the IRS need?
- What is the Taxpayer Bill of Rights?
- How does the IRS notify you of an audit?
- How long will the audit take?
- What is the IRS audit statute of limitations?
- What are IRS audit penalties?
What information does the IRS need?
The IRS will tell you what records they want to see. The records are documents that support claims on your tax returns. Here are just some of the records the IRS might ask you for:
- Canceled checks
- Legal papers
- Loan agreements
- Employment documents
What is the Taxpayer Bill of Rights?
In 2014, the IRS announced the Taxpayer Bill of Rights, a document meant to help taxpayers understand the complexity of taxes. There are 10 basic rights that apply to general taxpayers as well as those being audited:
- The Right to Be Informed
- The Right to Quality Service
- The Right to Pay No More than the Correct Amount of Tax
- The Right to Challenge the IRS’s Position and Be Heard
- The Right to Appeal an IRS Decision in an Independent Forum
- The Right to Finality
- The Right to Privacy
- The Right to Confidentiality
- The Right to Retain Representation
- The Right to a Fair and Just Tax System
How does the IRS notify you of an audit?
If you are getting audited by the IRS, you will receive a notice in the mail. The IRS will not begin an audit with a telephone call or email.
The IRS tax notice will give you contact information and instructions for what to do next.
How long does an IRS audit take?
According to the IRS, the audit process does not have a set time limit. When you receive the notice is when the IRS audit process begins.
The IRS audit process timeline is determined by how accurate your records are, the type of audit, you and the auditor’s availability, and your response to the audit findings.
What is the IRS audit statute of limitations?
The IRS audit statute of limitations describes how far back the IRS can go into your tax returns. According to the IRS, the time period varies depending on how big of an error they catch.
Typically, the IRS can use any small business tax return filed within the last three years. However, the IRS can go back six years (or more in rare cases) if there is a big mistake. Most audits only consist of returns filed within the last two years.
By law, you are required to keep all the records you used to prepare your tax return for at least three years from the date you file the tax return. You might want to keep accurate records longer so you are prepared if an auditor uses tax returns from six years ago.
What are IRS audit penalties?
If the audit concludes that you did not pay enough taxes, you could face penalties in addition to any unpaid taxes you might have. Here are some of reasons you might be penalized, according to the IRS:
- Understating your tax liability
- Failing to file
- Failing to pay
- Errors on tax return
IRS tax audit penalties range from owing money to prison time. Take a look at some of the IRS audit penalties:
The IRS can apply an additional percentage to the amount of taxes you owe them:
- 20% or 40% penalty: If you made a mistake on your tax return, you could face a 20% or 40% penalty, depending on how severe the error is.
- 75% penalty: This is reserved for more serious cases, like fraud.
If you have a significant tax debt that you are unable to pay, the IRS can seize your property and sell it to get the money you owe them if you aren’t protected by limited liability.
Prison time is reserved for those who attempt to get away with criminal tax evasion. Tax evasion is the intentional underpayment of tax debts. Business owners purposely committing fraud to get out of paying taxes can face a jail sentence up to five years, fines up to $250,000 or $500,000 for corporations, or both.
Fraud is extremely different than negligence — if you make a mistake on your tax return, the IRS will determine if it is negligence or fraud.
Understanding what happens when you get audited by the IRS can save you unnecessary worry, help you know your rights, and remind you to keep your records together. Check out this easy-to-read infographic:
The IRS has reported that tax audits have declined in the last few years. The budget cuts in recent years have left the agency with fewer IRS agents to catch missteps and collect revenue.
As mentioned in Forbes, the number of audits dropped 16% just from the previous year, and that was the sixth year in a row for fewer audits. The chances of audit have always been low, but they have declined even more over the last few years, considerably less than 1%. Sure that makes for a lot of happy taxpayers. No one wants to be audited.
However, infrequent audits can hurt you. Low IRS audit rates are likely to embolden some taxpayers and tax advisers. They may feel that they are in the clear. Statistically speaking, they might be. But someone is going to get audited. And you should prepare as if you will be audited, not assuming that you will not be.
If you are fully prepared for an audit, with documentation, receipts, log books, perhaps even a tax opinion, you probably won’t need them! That is the odd karma about being prepared. Conversely, suppose you figure that you don’t need any of those things, and can produce them if and when you are audited? You guessed it, you probably will get audited. What’s more, you won’t be able to quickly produce all the things you think you can.
Even if you do, the documents will almost certainly be much less persuasive to the IRS than contemporaneous ones would be. And a tax opinion prepared at audit time is rarely entitled to much deference! In short, prepare up front and assume that you’ll be audited. How long are you at risk? Start with the basic rule that the IRS usually has three years after you file to audit you. But this is often extended, sometimes voluntarily. Frequently, the IRS says it needs more time to audit. The IRS asks you to sign a form extending the statute, usually for a year. Most tax advisers tell clients to agree, but get some professional advice. You may be able to limit the time or scope.
An exception to the three year rule is if you omit more than 25% of your income. In that case, the IRS gets double that time, six years. The IRS also gets six years to audit if you omitted more than $5,000 of foreign income (say, interest on an overseas account). For unfiled tax returns, criminal violations or fraud, the IRS has no time limit. In most criminal or civil tax cases, though, the practical limit is six years. And in some cases, even if you file your return, if you miss some tax forms, the IRS can audit forever.
The statute of limitations on taxes is a fundamental rule allowing taxpayers to cut off their exposure. You should never throw out your old tax returns—ever. But after a time—many people say seven years or so—you should be able to throw out records and receipts. Still, some records should be kept forever—like receipts for improvements to property that go into your basis. If you remodel your kitchen and sell your house 20 years later, the receipts for your remodeling job are still relevant. It is comforting to know that your chances of an IRS audit are declining. But someone will be audited, and you might be the one. The best way to avoid much of the pain is to be prepared.
So, you want to start your own online business? Before you start designing your own website or webpage, make sure that you know all about the do’s and don’t of
starting an online business and that includes the technical, financial and legal matters of the business.
When you decide to start a business, you should be aware and prepared for whatever legal or financial issues that may arise. If you think that you can escape from paying taxes by starting your very own online business, think again – your dreamy balloon may burst once you get into complications regarding taxes and your online business.
The Truth About The Internet Being A Tax-Free Zone
More and more shoppers are getting lured by online shops and retailers because of their famous tag line of “no-tax shopping”. What most people don’t know is that that certain tag line used to lure online shoppers is not applicable to all states.
For you to be able to understand this concept better, here is an example: A woman from Indiana regularly purchases exotic orchids through an online shop based on Switzerland.
Since she purchases and sends her payments directly to Switzerland, she is not obliged to pay any sales tax in Indiana since her orchid supplier has all of its facilities in Switzerland.
A few months later, the exotic orchid supplier of that woman has decided to open a store in Indiana. The woman still purchases online but she already has to pay for the sales tax of the orchid since there is already a store based in the place where she is staying.
In other words, the responsibility to pay for taxes is an interdependent status between the consumer and the supplier. By that example, we can Come to a conclusion that the Internet is not really a tax-free zone. It depends on the location as well as the type of business that one is involved in.
The Responsibility To Pay Sales Tax
Admit it, nobody really loves to pay taxes. Perhaps even the rich people are irritated come tax-paying time because it is sometimes a tedious and complicated
process. There are a lot of rules and laws to refer to before one can actually come to a clean calculation of the taxes that he or she must pay.
If an individual lives in a state that is known for collecting “sales tax”, you are not exempted from it even though you try to escape it by making a lot of purchasing through the Internet because you are still required to pay for the “sales tax” directly to the state.
When you pay a “sales tax” directly to the state, it is no longer called a “Sales tax” but rather a “use” tax. Perhaps the only difference between “sales” tax
and “use” tax boils down as to which person – the buyer or the seller – pays the state. “Use” taxes are usually used by the state to make sure that they collect the right amount of revenue on every taxable item purchased within the state borders.
There are actually still a lot of points to be discussed about taxes and online business and the points mentioned here are just what we may call “a tip of the iceberg”.
In determining what’s the right thing to do in handling taxes and your online business, it would be best to go beyond researching for legal answers alone. Consulting the help of lawyers and other legal professionals would probably benefit you more than you expect.
With products like Turbo Tax improving, many wonder where this leaves accountants. Ironically, the evolving role of accountants is helping people save on their taxes.
The Evolving Role of Accountants
Given the fact that paying taxes isn’t the most popular of tasks, most people don’t give much thought to the role of accountants. Going to your accountant is often viewed much like going to the dentist. It is not going to be fun, but it needs to be done. While a toothache isn’t fun, an audit is one of the biggest fears of most taxpayers. I guarantee you that no contestant would survive if the Fear Factor television show made them undergo a tax audit!
Given this situation, it is hardly surprising that most people view the role of an accountant as the preparation of confusing tax returns. With the advent of tax preparation software programs, many wonder why they need an accountant. More than a few accountants have probably wondered as much also.
There is no disputing the tax preparation software revolution has led to a different role for most accountants. Ironically, this is good for both taxpayers and accountants. No longer does an accountant count on spending time filing out tax returns. Heck, even accountants use software to do this now!
The role of accountants is now to do tax planning for their clients. The best accountant is one that drags you into his or her office once a year to look at your finances and plan a strategy to limit what you will pay the IRS. This should occur at some point during the beginning of the tax year, not a week before your tax returns are due!
Unfortunately, a majority of accountants never took this step since they were to busy preparing the mountain of tax returns the federal and state governments now require. The evolving role of accountants, however, has let them return to the traditional position of coming up with proactive strategies to limit your tax bill. This is more interesting for them and obviously beneficial for you.
Many thought tax software would eliminate much of the need for accountants. Ironically, the changes in their duties has returned them to their traditional role of giving tax planning advice.