U.S. and International Tax Implications of Investing in Bitcoin and Other Cryptocurrencies
The rise of cryptocurrencies such as Bitcoin, Ethereum and Dogecoin has created a new set of challenges when it comes to taxation. In the United States, digital assets are treated as property for tax purposes and must be reported gross income on your income tax returns. For investors wanting to remain compliant with local regulations, understanding U.S. and international tax implications of investing in cryptocurrencies is key. In this blog, we'll explore the basics of crypto taxation and provide an overview of what you need to know in order to remain compliant with tax legislation. Join us as we dive into the world of cryptocurrency taxes so you can stay current with your reporting obligations!
What is a cryptocurrency?
A cryptocurrency is a digital virtual currency that is secured by cryptography and decentralized on a distributed ledger, such as blockchain. Cryptocurrencies are not issued by any central authority such as a government, bank or other financial institution and operate independently of traditional financial organizations. Bitcoin was the first digital currency or virtual currency to be created in 2009, and since then many more cryptocurrencies have been created.
U.S. Tax Implications for Cryptocurrency Investors
In the United States, digital assets like cryptocurrencies or any other virtual currency are treated as property for tax purposes and general tax principles applicable to property transactions apply to crypto trading. Since their emergence in 2009, these digital assets have become increasingly popular as a medium of exchange. But with all this new technology comes an added layer of complexity when it comes to taxes. There are many tax consequences for investing in crypto currencies. You want to plan your investment so you pay capital gains tax and not ordinary income tax.
What are smart contracts?
Smart contracts are digital agreements or protocols that allow for automatic execution of an action when certain conditions are met. They are written in code, stored on a blockchain and enforced by a network of computers that verify each transaction. Smart contracts are revolutionizing the way we manage money, investments and cryptocurrency transactions. By utilizing a secure network of computers to verify each transaction, smart contracts offer unprecedented levels of security and efficiency when it comes to managing digital assets. They provide an automated system for executing actions based on predetermined conditions, enabling users to quickly and securely complete their financial activities with confidence.
How are crypto treated for tax purposes?
Cryptocurrencies are treated as property for federal income tax purposes here in the United States. This means that any profits or losses made through cryptocurrency transactions must be reported on your return. It is essential to understand the U.S. and international tax implications of investing in bitcoin and other cryptocurrencies and digital assets, so that you can remain compliant with local regulations and pay taxes on your investments. In terms of taxation, crypto assets can be subject to capital gain tax rates or ordinary income tax rates as well as there are many reporting requirements when the us and international tax implications of investing in bitcoin and other cryptocurrencies and crypto.
What are tokens?
In the cryptocurrency space, tokens are digital assets that may be used to represent an asset or utility. Tokens can also be classified as either security tokens or utility tokens depending on the specific characteristics and functions of each token. Security tokens typically derive their value from an external, tradable asset and are subject to federal securities and regulations while utility tokens tend to be used as a medium of exchange within a particular platform or application and are exempt from such regulations.
How is virtual currency treated for tax purposes worldwide?
For tax purposes, most countries treat cryptocurrencies as property rather than currency. This means that any gains or losses made from buying and selling cryptocurrencies are subject to capital gains tax. Depending on the country, other taxes may also apply such as value-added tax (VAT) or corporation tax. Additionally, there are a variety of regulations that must be followed in order to remain compliant with international taxation laws.
How does the IRS treat cryptocurrencies?
The Internal Revenue Service (IRS) in the United States treats cryptocurrencies as property, which means that capital gains tax applies to any profits made from trading or disposing of them. This applies to both long-term and short-term capital gains, meaning that investors are liable for different levels of taxation depending on how long they have held the asset.
For example, any profits made within one tax year after buying the cryptocurrency are subject to the tax rate for short-term capital gains taxes; whereas any profits made after one year are subject to the tax rate for long-term capital gains taxes. Additionally, the IRS requires individuals who earn any income or have any capital gain in cryptocurrency income during a tax year to report it. For more information on the tax treatment of property transactions, see Publication 544, Sales and Other Dispositions of Assets. You can find IRS guidance by visiting the IRS website.
What constitutes a taxable event?
A taxable event is any sale, exchange, or other disposition of property that results in a gain or loss. This includes cryptocurrency transactions such as buying, selling, exchanging and trading. Profits made from disposing of cryptocurrencies via taxable event are generally subject to capital gains taxes, which can vary depending on the length of time for which the asset was held and the investor’s tax bracket. The investor will pay capital gains tax or ordinary income tax. Investors should also be aware that there are other taxable events such as forks, airdrops and hard forks which could also trigger capital gains taxes. For federal tax purposes, you can have capital gains or capital losses.
Furthermore, it is important to remember that cryptocurrency transactions can be subject to state and local taxes depending on where you live. Overall, it is essential to understand the applicable tax laws before engaging in any cryptocurrency transactions.
What transactions involving digital assets do you need to report on your income tax return?
Transactions involving a digital asset are generally required to pay taxes and must be reported on your tax return. You will most likely have to report and pay taxes on the following transactions involving digital assets:
Trading cryptocurrency for US dollars or foreign currency
Trading one type of cryptocurrency for another
Exchange of a digital asset for property, goods, or services
Receipt of a digital asset as payment for goods or services
Receipt of a new digital asset as a result of a hard fork
Receipt of a new digital asset as a result of mining or staking activities
Any other disposition of a financial interest in a digital asset
Receipt or transfer of a digital asset for free (without providing any consideration) that does not qualify as a bona fide gift
Transferring a digital asset as a bona fide gift if the donor exceeds the annual gift exclusion amount.
Earning income from cryptocurrency holdings
Will I have to recognize gains or losses on the sale of virtual currency?
Yes. When you sell virtual currency, you must recognize any capital gain or capital loss on the sale, subject to any limitations on the deductibility of capital losses. Capital gains tax is a tax on the profit made from the sale of an asset, which is calculated by deducting your cost basis on the digital currency from the selling price. If you buy a cryptocurrency for $100 and sell it for $300, you have made a capital gain of $200, which is subject to capital gains tax.
Tracking your basis
To accurately calculate your capital gains or losses, you will need to keep track of the basis of your cryptocurrency holdings. Basis refers to the original cost of an asset, including any fees or commissions paid to acquire it. For example, if you buy one Bitcoin for $50,000 and pay a $1,000 fee, your basis for that Bitcoin is $51,000. If you later sell that Bitcoin for $60,000, your your capital gain or loss is $9,000.
Keeping accurate records of your cost basis can be challenging, especially if you have made multiple transactions over a long period of time. However, it is essential to do so to ensure you are reporting your gains and losses correctly.
Crypto-to-crypto transactions, such as trading Bitcoin for Ethereum, are also subject to capital gains tax. In this case, you will need to calculate the fair market value of the cryptocurrency you are receiving in exchange for the one you are selling. For example, if you trade one Bitcoin for 10 Ethereum, and at the time of the trade, one Ethereum is worth $4,000, the fair market value of the 10 Ethereum you received is $40,000. If your own cost basis amount for the one Bitcoin you sold is $50,000, you have made a capital loss of $10,000.
Mining and staking
If you earn cryptocurrency through mining or staking, the fair market value of the coins you receive is subject to income tax. In this case, the fair market value of the coins on the day you received them is considered taxable income that tax year. For example, if you mine one Bitcoin in 2023, and on the day you receive it, one Bitcoin has a fair market value of $100,000, you will need to report $100,000 in income for that year.
Cryptocurrency gifts and donations
Gifting or donating cryptocurrency can also have tax implications. If you give a digital asset to someone as a gift, the recipient will generally not have to pay any taxes on the value of the asset at the time they receive it. However, if you give more than $15,000 worth of cryptocurrency in a single year, you may be required to file a gift tax return. Additionally, if you donate cryptocurrency or other capital assets to a charity or non-profit organization, you may be able to take a charitable contribution deduction for the value of the capital asset or other capital assets in the donation. It is important to remember that these rules and regulations can change from year to year and vary from country to country.
International taxation of cryptocurrency transactions
The taxation of crypto-currency transactions is complex and varies depending on the country or jurisdiction. International tax laws are constantly evolving, so it is important to stay up to date with any changes and consult a qualified professional when necessary. Generally, most countries tax profits from cryptocurrency trading as income, while others may treat it as capital gains. Depending on the country, other taxes may also apply such as value-added tax (VAT) or corporation tax or capital gains tax. You should work with an international tax advisor providing international services related to cryptocurrency to help you be in compliance with international tax laws.
How much is crypto taxed in the USA?
In the United States, cryptocurrency investors are subject to capital gains tax on their crypto-to-crypto transactions and mining/staking income. The taxable amount is based on the fair market value of the cryptocurrency at the time of sale or receipt. Short-term capital gains and losses, which refer to any assets held for a year or less, are taxed as ordinary income, while long-term capital gains, referring to assets held for more than a year, are taxed at lower rates. You'll pay up to 37% tax on short-term capital gains or ordinary income and crypto income and between 0% to 20% tax on long-term capital gains. The amount of the tax rate that you'll pay tax on crypto capital gain depends on whether you have short-term capital gains or long term capital gains.
Wash sale rule and crypto
The "wash sale rule" applies to all capital losses and is intended to prevent taxpayers from avoiding tax by selling an asset below fair market at a loss, then buying it back shortly afterwards. This rule affects crypto investors similarly in that if they sell any virtual assets for a loss and repurchase the same assets within 30 days of the sale, then the losses cannot be claimed as a deduction on their return. Furthermore, the wash sale rule also applies to similar assets held in different investment accounts, so an investor must be careful when executing transactions across multiple exchanges or wallets.
IRS letter for cryptocurrency investors
A few years ago, the Internal Revenue Service (IRS) began sending letters to cryptocurrency investors. If you received one of these letters, you should take the letter very seriously by reviewing your tax filings and when necessary, amending your past returns and paying back taxes to avoid major issues with the government. If you have not yet received a letter, your obligations are no different. All cryptocurrency investors are subject to the requirements of the Internal Revenue Code, and failure to meet these requirements (including failure to correct past violations) can have costly consequences.
International tax consequences of cryptocurrency
If you live in one country and trade cryptocurrency on an exchange based in another country, you may be subject to taxation in both jurisdictions. Each country has its own tax laws, and it is essential to understand the regulations in both your homes. In most countries, cryptocurrencies will be subject to income tax or capital gains tax.
Section 988 of the tax code outlines the rules governing the treatment of the exchange gain or loss from transactions denominated in a currency other than a taxpayer's functional currency (foreign currency gain or loss). For transactions using cryptocurrency, Notice 2014-21 provides that cryptocurrency is not treated as currency that could generate foreign currency gain or loss. However, since the guidance in Notice 2014-21 was based on law in place at that time, it leaves open the possibility that foreign currency gain or loss could apply to virtual currencies in the future.
This guidance states that although cryptocurrency is not treated as a fiat currency that can generate foreign currency gain or loss, the possibility of such a real currency gain or loss arising in the future still exists. As such, taxpayers must exercise caution when engaging in transactions involving virtual currencies and consider the potential international tax implications associated with any exchange gains or losses.
How crypto tax rules affect American Expats
The crypto tax rules for U.S. expats are complex and must be taken seriously. This is because the U.S. taxes its citizens on their worldwide income, regardless of where they live. Additionally, foreign countries have started to impose varying levels of taxation on cryptocurrencies, which may not always be consistent with the IRS framework. As a result of crypto tax rates, U.S. expats must exercise caution when engaging in transactions involving virtual currencies and consider the potential tax implications associated with any exchange gains or losses. You should work with an international tax advisor to help you report your crypto currency transactions.
Crypto income and the foreign earned income exclusion
U.S. Expats can use the Foreign Earned Income Exclusion to exclude up to the allowed exempted amount of foreign-source earned income from crypto currency. Traders with self employment income must make an election to be treated as an active trader and they will receive tax benefits and a preferential tax treatment for crypto taxes. Their income will be classified as ordinary income. Thus, the taxpayer with self employment tax will be eligible to be excluded from Foreign Earned Income Exclusion.
Can you claim the foreign tax credit on crypto currency?
Yes, U.S. Expats can claim the Foreign Tax Credit on crypto currency. To qualify for the credit, you must have paid or accrued foreign income tax to a qualifying country and your foreign taxes must not be refundable or transferable. If your crypto income is classified as ordinary income, then you can claim the same tax rate and the foreign tax deduction or credits on the taxes paid. If your crypto income is classified as capital gains, then you can only claim a foreign tax credit on the capital gain income or offset capital gains portion of the taxes paid.
In which jurisdictions must you file tax returns related to cryptocurrency?
Generally speaking, any jurisdiction in which cryptocurrency activity has taken place or income has been generated must be reported on a federal income tax return. This includes countries where the taxpayer has both engaged in transactions and earned income from their virtual currency holdings. Additionally, some countries may require taxpayers to report their cryptocurrency activity regardless of whether income has been generated or not. It is important to familiarize yourself with the tax laws in your jurisdiction and seek professional advice if needed. If you're a United States citizen and live abroad, you might be required to report your income on tax returns.
Keep records of crypto transactions for taxes
It's imperative that cryptocurrencies be kept in a detailed logbook for future purchases. The IRS argues that a taxpayer must keep a record that can show how they are doing. Therefore, you should keep a minimum record of crypto transactions. IRS says taxpayers must keep enough information to prove their claim in an IRS filing. You should make sure that you have documented all items of taxable income, expenses and tax deductions on your tax return. Remember to maintain records of your transactions.
Cryptocurrency information reporting requirements
Crypto-currency trading platforms and brokers often use varying approaches to report crypto transactions for tax evasion. The IRS issued summons to cryptocurrency exchange firms for information regarding cryptocurrency transactions in 2016 despite the fact that there were no forensics of the transactions. On the U.S. income tax return, the taxpayer must also answer on Form 1040 page 1 if they have purchased virtual assets.
Does the IRS know I own bitcoin?
Yes, the IRS is aware of cryptocurrency investments. The investments are reported by third parties to the IRS. The IRS also issues letters to taxpayers reminding them of their reporting obligations, as well as summonses to cryptocurrency exchange firms for information regarding any transactions they've facilitated. To remain compliant for federal tax purposes and avoid penalties, taxpayers must accurately report their crypto investments. Even if your income is below the threshold required to file a tax return, you still need to report any cryptocurrency transactions on Form 1040. With the IRS taking a more aggressive stance on virtual currency taxes, it’s better to be safe than sorry.
What happens if you don't report cryptocurrency on taxes?
Taxpayers who fail to report cryptocurrency transactions gross income or investments on their returns could face penalties or financial interest from the IRS. These include interest payments, failure-to-file fines and accuracy-related penalties. Additionally, those who have willfully attempted to evade taxes can be subject to criminal prosecution which carries a maximum prison sentence of five years and a fine of up to $250,000.
For these reasons, it is important that all cryptocurrency investors understand the relevant tax regulations and make sure they are reporting their activities accurately. Taxpayers should keep detailed records of their transactions in order to ensure accurate filings when filing returns. Failure to do so could lead to costly penalties or even criminal prosecution.
How does the IRS audit bitcoin and other cryptocurrency investors?
Bitcoin and other crypto audits are similar to any other IRS audit type as they aim to assess how much tax liability the taxpayer has failed to pay tax on. Certain cryptocurrency investors will be targeted for audit because they're being disclosed by third parties. The IRS auditor will review all cryptocurrency transactions to determine whether you have reported all the transactions correctly.
What happens when your cryptocurrency transactions are audited by the IRS?
If the Internal Revenue Service audits a taxpayer’s cryptocurrency transactions and finds discrepancies in a tax bill, the individual may be required to pay interest, fines and even penalties. The Internal Revenue Service may also impose additional taxes or request that any outstanding amounts that owe taxes are paid promptly. Additionally, those who have willfully attempted to evade taxes can be subject to criminal prosecution, which carries a maximum prison sentence of five years and a fine of up to $250,000. It is important to ensure your tax bill is accurate.
How do you get ready for a cryptocurrency audit?
To prepare for an audit, it is important that investors have accurate records of their transactions. You have to be able to show your adjusted gross income calculation from crypto currency transactions as well as being able to justify every tax deduction on your return. Taxpayers must be able to provide detailed information on the type of asset and when it was bought or sold as well as proof of any capital losses or gains realized. Additionally, taxpayers should keep any relevant communications with exchanges, brokers or service providers. These documents can help to prove that the taxpayer has reported their activities accurately and is in compliance with taxation regulations. The key to get ready for an audit is to have as much information as possible so you can justify your tax positions.
Cryptocurrency investors be aware
In conclusion, cryptocurrency investors must be aware of the various tax implications associated with their trades. Depending on where you live and trade, you may need to pay taxes in both your home country as well as abroad. Additionally, foreign currency gains or losses from transactions denominated in a fiat currency, other than your functional one can also apply to virtual currencies due to the guidance outlined by Notice 2014-21. As such, it is important for all crypto traders to understand the relevant tax regulations and ensure they are properly filing their returns accordingly. If you have received an IRS letter regarding cryptocurrency investments, take it seriously and make sure that any past violations of tax legislation are addressed promptly before costly consequences arise.
Here are the top five tax tips on cryptocurrency:
Keep records of all cryptocurrency transactions: It is important to keep accurate records of all cryptocurrency transactions, including purchases, sales, and trades. This information will be useful when calculating capital gains or losses.
Know the taxable event: A taxable event is any event that results in a capital gain or loss. When it comes to cryptocurrency, a taxable event occurs when you sell, trade, or exchange cryptocurrency for another asset, such as cash, goods, or services.
Use specific identification method to calculate gains and losses: The IRS allows taxpayers to choose which cryptocurrency to sell, trade, or exchange. This is known as the specific identification method. By choosing the cryptocurrency with the highest cost basis, you can minimize your capital gains and reduce your tax liability.
Report all cryptocurrency income: Any income earned from cryptocurrency investments, such as mining, staking, or airdrops, is taxable income and must be reported on your tax return. Failure to report cryptocurrency income can result in penalties and interest.
Consider using a professional: Cryptocurrency taxation can be complex, and it is recommended to consult with a tax professional who is experienced in cryptocurrency tax compliance. A professional can help you navigate the complex tax regulations and ensure that you are reporting your cryptocurrency investments correctly.
To finalize this blog, cryptocurrency taxation can be complex and confusing. It is important to keep accurate records of all transactions, understand the taxable event, use the specific identification method to calculate gains and losses, report all cryptocurrency income, and consider using a professional tax attorney to ensure compliance with tax laws and regulations.
In the United States, all digital currencies and assets are treated as property for tax purposes, so general principles applicable to property transactions apply to crypto taxes. As such, it is essential for investors to understand these laws and remain compliant in order to avoid costly penalties or even criminal prosecution.
How H&CO can help
At H&CO, we provide comprehensive services for cryptocurrency investors to ensure they are compliant with US regulations and manage their tax risks. Our team of experts can help you understand the tax implications associated with your U.S. and international cryptocurrency investments, advise on potentially, taxable transactions and taxable events, and provide guidance on filing your taxes correctly as well as personalized investment advice. We will also work with you to identify any past violations for digital currencies and address those promptly before they become costly. With our help, you can rest assured that your investments are compliant with U.S. tax laws and international tax laws.
H&CO's bilingual trusted CPA Tax Advisors have been doing international tax preparation for high-net-worth individuals with significant income, business owners, investors, global families, and foreign individuals with complex tax needs, for over 30 years. You can talk to our CPAs in one of our offices near you in Miami, Coral Gables, Aventura, or Fort Lauderdale.