Why IRS wants you to pay taxes on your crypto assets?
Cryptocurrency is gaining more popularity than ever. The Current Bitcoin valuation is moving between 35.8K USD to 37.6K USD. It talks about the market demand for it and how frequently merchants use it for exchanges. A lot of these exchanges happen overseas.
The downside is when this huge amount of foreign money enters the domestic market, they increase the market volatility. Also, because of its volatile value, some huge federal losses may incur.
Many countries have strong capital controls in place to limit the flow of money by imposing high taxes. These capital checks and taxes have pushed the use of cryptocurrency—legal or otherwise—to avoid paying high taxes.
Cryptocurrencies do not come through a centralized bank system like conventional currencies. Hence, it is not easy to regulate them. The IRS wants to bring cryptocurrency into the mainstream to minimize unlawful usages such as tax avoidance or illegal purchases or sales abroad.
Since they hold value equivalent to real money and are not actual currencies, IRS in the United States regards cryptocurrency as assets or property (2014 IRS declaration) and they are taxable. Therefore, everyone who owns or sells, transfers, or exchanges goods for virtual money must declare the transactions on their income tax return.
Common Crypto Activities and How They’re Taxed
Bitcoin in many online sites is not yet an approved form of payment. You cannot spend it in your local shop. But, the market is nonetheless vibrant. Many forms of virtual currencies like Ethereum, Cardano, Binance coins, Tether, other than bitcoins, are used for the following purposes.
- Paying for subscriptions, services, goods like digital artwork.
- For exchanging funds.
- To trade for traditional currencies like dollars.
Cryptocurrency exchanges are not like typical bank transactions. They go through complex encryption in a decentralized blockchain network and are validated by a network of servers, a process known as mining.
Crypto coins traded via dApps like Uniswap, Pankcakeswap, Coinbase can be stored, managed, and accessed for payments through Trust Wallet, Metamask, Coinbase wallet, and other Defi wallets.
For all transactions done through these apps or any other exchange with a financial interest, they have to be disclosed to IRS and are taxable.
Here are mainly three ways virtual currencies are taxed.
- If you bought cryptocurrency on some crypto exchange for the goal of long-term investment, it is taxed under property or capital assets. Also, as it happens in the case of stocks, any gain or loss from the sale or exchange of a cryptocurrency will be taxed as a capital gain or loss. So it must be recorded on your income tax form. They can be further categorized into short-term gains or STGC (holding it for less than 36 months) and long-term gains or LTGC (36 months or more). The taxable amount will differ based on this.
- When you often deal in cryptocurrencies and the transactions for the same are enormous, the taxpayer is considered to be trading in cryptocurrencies. Here the income from the sale of cryptocurrencies is taxable under business income.
- You have to pay tax for currency exchanges. Say if you buy Altcoin with Bitcoin, you are basically selling it. Therefore, you must report the differentiating price between the two currencies. As well as keep track of the value of Altcoin at the point of purchase. You will be taxed on the difference value as well.
What if you don’t report your cryptocurrency transactions?
If you fail to report any of your cryptocurrency transactions deliberately or not, you may be accused of tax evasion. You could be charged for penalties like it would apply for traditional money.
You may believe, there is a possibility that one can hide the information as cryptocurrency transactions are meant to be anonymous. It holds unless it can’t be linked to the address of the trader. Hence, they are not completely untraceable.
The IRS Fraud Enforcement Office is working on these concerns as part of their Operation Hidden Treasure effort, which aims to discover unreported crypto earnings and their owners.
Can you be fined for not declaring cryptocurrency holdings over recent years?
Recently, the IRS has included a straightforward question about cryptocurrency possessions on the first page of the 2020 Federal income tax form. You have to check the ‘Yes’ box if you have had any virtual currency transactions. That holds even if you are exchanging it for free or into another form of virtual currency. Incorrect or incomplete reporting may lead to hefty fines and interests.
In the U.S, there could be criminal charges against you for intentional tax evasion. It can lead to five years in imprisonment and a fine of up to $250,000 in extreme cases.
Do You Still Need to Report Small Crypto Transactions?
IRS mainly targets the traders or owners who are holding unreported cryptocurrencies of large value. But the statement on the 2020 income tax form asking for virtual currency holding is sort of ambiguous. It does not state the details about holding periods or small transactions. So it is understood you have to report all small transactions where you have used cryptocurrency, including the ones to book a hotel or an account deposit in online betting or subscriptions.
You don’t have to report under the following circumstances.
- If you have donated them to an eligible non-profit organization or for a charity that is exempted from tax.
- Purchasing cryptocurrency with fiat currency.
- Coins transferring between wallet apps account, owned by the same person.
What if you spent your digital assets at a retailer that accepts crypto?
If you have used your virtual currency to gain anything in return, it only means you have sold it. There are two possibilities.
- If you have sold it for a profit, the taxable amount will vary based on the increased value of the coins from the time you are holding it.
- If you have sold it for a loss or have lost the coins, the tax will be exempted. You don’t have to pay anything.
Say you have used Ethereum to purchase a sports car worth $55,000. The same Ethereum was valued at $4000 two years back when you purchased it. Then you will be taxed on the capital gains.