While many joke about that unfortunate boating accident that magically makes all bitcoin disappear, the vast majority of us know that as the popular meme goes, “One does not simply not pay taxes.” This article is geared toward the U.S. tax code, as the way bitcoin is treated varies depending on jurisdiction. Once the IRS declared that virtual currency, such as bitcoin, would be taxed as “property” and not currency, it became the obligation of bitcoin holders to pay taxes on any gains (See IRS Notice 2014-21, Guidance on Virtual Currency, March 25, 2014).
These gains include, but are not limited to, earnings from any type of exchange or sale; gains from selling that may have been made upon the purchase of a good or service with bitcoin (including those lambos); and on fair market value of any mined bitcoin, as of the date of receipt. Needless to say, record keeping can be particularly burdensome for the unwary, inexperienced or careless.
For individuals holding bitcoin for investment purposes, gains or losses from a sale of bitcoin, or virtual currency, is reported on IRS Form 1040 Schedule D and IRS Form 8949 (Sales and Other Dispositions of Capital Assets). Individuals with realized gains on bitcoin held for one year or less are taxed with ordinary tax rates, while those that hold for over one year are subjected to capital gains tax rates.
It’s important to have IRS Form 8949 in mind when keeping track of transactions because the IRS requires detailed information for each transaction. This includes a description of the amount and type of cryptocurrency, when it was acquired and sold, the amount of proceeds from the sale, the cost or basis when acquired, and the amount of the gain or loss. Due to the IRS prohibiting the use of like-kind exchanges covered by Section 1031(a) for cryptocurrency transactions, taxable gains or losses must be recognized at the time that any cryptocurrency is converted into another cryptocurrency — a signal that no one should ever trade their bitcoin.
For those who think the anonymity of Bitcoin provides enough cover while moving one’s bitcoins off an exchange, keep in mind that there is already less privacy than one would think. Independent contractors, gig workers or basically anyone who receives a bitcoin payment for goods or services over $600 in the course of trade or business is already subject to informational reporting to the IRS. Moreover, laws such as the Foreign Account Tax Compliance Act (FATCA), require most foreign bank and non-bank institutions to report information regarding U.S. residents who maintain accounts in those institutions. Going forward, bank accounts with bitcoin transactions may attract more attention as bitcoin goes mainstream.
The general trend is toward more regulation and scrutiny of bitcoin transactions to identify tax liability issues. Just in April 2021, a federal court judge authorized the IRS to use subpoenas to obtain information on those with over $20,000 in transactions on two bitcoin exchanges.
Just as eBay and PayPal have been required for several years to report and provide a 1099k for 200 transactions and more than $20,000 in gross sales in a calendar year, it’s reasonable to expect exchanges to eventually follow similar reporting guidelines in the future, as federal law evolves over time. In fact, it may become the norm to report $600 or more.
All in all, it’s important to be as careful and accurate as possible with bitcoin taxation. While most bitcoin HODLers will not have any tax reporting concerns as long as nothing is done to trigger a loss or gain, those engaging in taxable events, such as those juicy arbitrage plays, will be subject to taxes. Most trades count as short-term capital gains that are taxed up to 37%, depending on the tax bracket. However, the best benefit of holding bitcoin for over a year is to avoid short-term tax rates in favor of long term capital gains rates. Those long-term rates are usually between 15 to 25%, which are much lower.
Fortunately, most exchanges provide ways to download transactions so accounting is less of a headache. As always, consult with tax professionals regarding your obligations and track those filing deadlines. Hopefully as bitcoin continues to rocket to the moon, the pain of paying taxes on any bitcoin income will feel less painful.
This is a guest post by S.J. Ware. Opinions expressed are entirely her own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.