Taxes. They are, unfortunately, a condition of modern life. As the old saying goes, the only things that are certain are death and taxes.
Even with that certainty, a surprisingly large number of Americans who invest in cryptocurrencies were hit with unexpected taxes this year. Sabrina Toppa with The Street writes,
More than 10% of surveyed American millennials [in a recent multi-state survey] say they’ve received a larger-than-expected crypto tax bill after selling digital assets — an event that typically triggers federal capital gains taxes, or taxes on profits from such sales.
In fact, 38% of respondents said that they weren’t aware that generating a profit from the sale of cryptocurrencies is taxable.
38%.
Now, that may be because millennials were the demographic who were most likely to own cryptocurrencies, so, it’s possible that the unfamiliarity with investment tax law could (at least in part) be due to age and (lack) of life experience.
You know what? The IRS doesn’t care. I sympathize, I really do. But ignorance of the law has never been an excuse.
It wasn’t just age, though, that correlated with unexpected taxes…
Interestingly, while age showed a definite correlation to the amount of awareness of investment tax law, location also showed a correlation.
In that survey, Wisconsin residents were most likely to be aware of tax law around profits from the sale of cryptocurrencies while residents of Florida (which has possibly the oldest age demographic in the nation) was the least familiar with tax laws around cryptocurrencies.
Neither of those statistics explain why over 1/5th of New Yorkers (21%) in that survey were hit with unexpected taxes having to do with selling crypto.
Why New York? To be fair, it may just be that more millennials currently live in New York than generally concentrate in other areas.
Or maybe New York may be a state with a heavier and more intrusive tax burden than most other states (which may mean that you would want to move out of New York if you live there now).
The good news is that there are some general guidelines to help your understanding about cryptocurrency taxes so that you can keep them in mind in your planning for your cryptocurrency transactions.
Basic guidelines for crypto taxes
The basic thing to remember is that, in most situations and for most purposes, cryptocurrencies are an investment. That means that they are subject to most of the same tax laws about capital gains and sales taxes as if you were selling any other investment. Andrew Dorn with NewsNation writes:
If you sold crypto, any gains or losses will typically impact your taxes, just like other investments taxed by the IRS. Spending crypto, such as using bitcoin to buy a car, also creates a taxable event.
That may make it sound like you have to pay taxes on cryptocurrencies at every turn, and make no mistake about it: the government wants their pound of flesh.
But not everything that you do with crypto is taxable. Dorn continues:
On the other hand, simply buying crypto with cash and holding it in a wallet isn’t taxable. Neither is transferring crypto between wallets you own.
If you think about it, taxes on your profit from cryptocurrency when you sell it and a lack of taxes on that cryptocurrency while you hold it (and it appreciates) is normal capital gains tax policy across investments in general.
To add insult to injury, even if your crypto trades didn’t profit you, you might still owe taxes. The Gordon Law Group explains:
For instance, if you received cryptocurrency as payment for services or through mining, the IRS considers this income, taxable at the fair market value at the time of receipt. This holds true regardless of subsequent price fluctuations. So, even if the crypto’s value drops after you receive it, you’re taxed based on its initial value.
Then, there’s this unexpected tax on crypto…
Cryptocurrencies do have another tax that can pop up that you’re unlikely to encounter with other types of investments, and that is because, unlike the vast majority of other types of investments, cryptocurrency is both an investment and…
… it is a currency, or money.
That means that if you are paid in cryptocurrency for work that you do or when someone buys something from you using crypto as payment, you have to treat that payment like a cash payment to you as a service provider or business owner for tax purposes.
Think of it this way: if you barter to design a website for someone in exchange for them giving you their 2005 Honda Accord to give to your teenage child for their first car, the IRS has you calculate the value of that Honda at the time that it was used for payment. You, then, have to include that value as part of your income on your taxes for the year.
So, to illustrate, if that Honda was worth $5,000 in the marketplace at the time that it was used as payment for your design of that website, then, you need to include that $5,000 as gross income in your taxes. Even though you never received cash, check, or a credit card payment for the work.
The IRS thinks of payments made in crypto in a similar way as the barter in the above example. They want you to report that valuation at the time of the transaction as income in your tax return.
Since we’re talking about payments made in crypto, it’s worth noting here that…
While you’ll be taxed on profits from crypto, you’ll most likely never pay your taxes in crypto
Why?
Because it simply doesn’t make financial sense. Let’s take Colorado as an example. You can actually pay your taxes in Colorado, but there are a few details that you would want to take into consideration before doing it. Toppa writes about when one gentleman intended to pay his state taxes in crypto,
First, the state government had partnered with PayPal to convert the funds into U.S. dollars, forcing him to transfer his crypto from a secure private wallet to a centralized platform. Second, he was asked to pay a 2% fee.
That’s right, it’s actually more expensive to pay your taxes in Colorado using cryptocurrency instead of just using dollars to do so.
The smarter approach, if you want to be wise with your money, is to continue thinking of cryptocurrencies as a long term investment to buy and hold instead of using it as currency. Again, from Toppa:
“For now, the prudent strategy is to pay taxes in dollars — a currency that loses purchasing power annually anyway — while keeping a ‘fiat out, hard assets in’ approach to wealth preservation,” [Chris] Kline said.
Like all investments, you would be wise to keep in mind the tax considerations both in how you handle your investments and in how you sell them so that you can keep as much of your profit in your pocket as possible.
That’s why we’ve made available our Crypto Tax Q&A for your perusal.
Now, listen, I’d never suggest breaking the law. But somehow crypto taxes still rub me the wrong way. I mean, when you’ve navigated the crypto market you’ve made the choice to take on significant risk in the anticipation of significant gain. Yet, when you cash in on those gains, taxes can claim a substantial portion of your profits. I believe it’s essential to employ strategies that allow you to retain more of your hard-earned gains without breaking the law. Trust me, I dated a CPA for a long time, and if she taught me one thing it’s you don’t mess with the IRS. The risks are not worth it!
That’s why tax-advantaged accounts, like a Digital IRA, are such an incredible advantage. You can choose to defer or even eliminate most tax liabilities. After all, you took the risk! Shouldn’t you get to keep more of the profit?
And if you want to make one of the smartest moves with your cryptocurrency allocation, I strongly recommend you learn more about applying a buy and hold strategy within Digital IRA. Personally, I believe high growth potential assets like cryptocurrency are ideal for a Digital Roth IRA. With a Roth IRA, you invest after-tax dollars and qualified withdrawals (including both your contributions and any investment gains) are entirely tax-free. This makes Roth IRAs a valuable tool for long-term retirement saving, especially with high-volatility, high-growth-potential assets. Like cryptocurrencies.
You don’t have to have a Digital Roth IRA to diversify your savings with cryptocurrency, of course. You could choose a Traditional-type IRA instead, in which case your contributions may be tax-deductible. But then you’ll still owe taxes on withdrawals… Less than ideal for cryptocurrency.
Whether you choose tax-free growth or tax-sheltered growth, it’s really worth your time to learn more about avoiding crypto tax shock. If you’re interested in avoiding those awkward letters from the IRS, you can open a Digital IRA right now (it only takes about five minutes). Or you can learn more about the benefits of diversifying your savings with cryptocurrency by requesting your free copy of the Insider’s Guide to Digital IRAs.
