Despite more than a decade of cryptocurrency mining and trading, the IRS has still not given a complete and detailed accounting of how crypto transactions should be taxed. The agency has, however, required some specific reporting each tax year. In 2022, we’ve seen yet more details on what’s expected and how taxpayers are required to report.
Cryptocurrency Tax Changes for 2022
The greatest change came towards the end of the 2021 tax year with the passage of the Infrastructure and Jobs Act. Buried in this long bill was language directed at cryptocurrencies, specifically aimed at those that facilitate the trading of “digital assets” (as the IRS calls cryptocurrencies).
The new law asserts that all crypto brokers must issue 1099-B forms to anyone who bought or sold cryptocurrencies through them over the previous tax year. This form is already filed by brokers for stock and bond transactions. Since cryptocurrencies are traded in a very different manner, this new rule has some issues.
First, the language of the law is a bit vague. According to Wyoming Senator Cynthia Lummis, Pennsylvania Senator Pat Toomey, and Oregon Senator Ron Wyden, the bill seems to lump everyone from exchange operators to bitcoin mining companies into the position of “broker.”
The issue with that is simple – a cryptocurrency mining company doesn’t have a record of exactly who buys the tokens it mines. Many such transactions are virtually anonymous, a key reason some investors own and mine cryptocurrencies.
Senators Lummis, Toomey, and Wyden, who is also the Senate Finance Committee Chairman, have introduced standalone bills and amendments that seek to narrow down the classification of the term “broker” for the cryptocurrency industry. Partly, they think it is only obfuscating how crypto transactions are reported. And there’s the risk of stifling innovation in the digital asset space.
A joint statement released by the trio of Senators reads:
“While Congress works to better understand and legislate on issues surrounding the development and transaction of cryptocurrencies, it should be wary of imposing burdensome regulations that may stifle innovation. By clarifying the definition of broker, our amendment will ensure non-financial intermediaries like miners, network validators, and other service providers—many of whom don’t even have the personal-identifying information needed to file a 1099 with the IRS—are not subject to the reporting requirements specified in the bipartisan infrastructure package,”
—Senator Pat Toomey, Joint Statement
Crypto developers, businesses that accept digital currencies and more may all be affected by this legislation. If it passes, it would be nearly impossible for all of the affected entities to actually report to the IRS.
But what does this mean for the regular taxpayer, who bought or sold crypto over the past year? The answer is: not much… yet.
The new rules in that infrastructure package don’t go into effect until 2023. Meaning no transactions will actually need to be reported in 1099-Bs until after you file for the 2023 tax year.
However, as things stand now if you traded cryptocurrencies or plan to, you might end up receiving the new form this year. As always, we recommend you speak to your tax specialist on how to use that information to properly file your taxes. If you need to locate a cryptocurrency-savvy tax professional, visit our directory here.
Pending Tax Legislation — Build Back Better Plan
2021 appears to be ending with a few unresolved crypto tax issues. The Biden Administration’s signature Build Back Better plan is still pending. In it, Congress inserted and has so far left in Section 138314, which changes the rules regarding IRA LLCs or “checkbook IRAs.” Some cryptocurrency investors with checkbook IRAs are paying close attention to this bill.
With a checkbook IRA, the IRA owner is also the manager or owner of an asset or business within the account. In essence, the owner becomes their own custodian (with all custodial responsibilities).
Currently, there is a limit an IRA owner could control of an entity like that. It’s 50%. In the Build Back Better plan, the ownership limit drops to a mere 10%. It also specifically forbids officers like CEOs, CFOs, and directors from investing in their companies (with their own retirement funds).
For most cryptocurrency investors, this new rule wouldn’t directly affect them no matter what happens with this proposal. However, for investors that own cryptocurrencies in a checkbook IRA, they could be in hot water. They would either have to liquidate their position in those cryptocurrencies by the end of 2022 or risk losing their IRA entirely.
Here at BitIRA, we don’t recommend checkbook IRAs for this reason. Instead, owning cryptocurrencies within an SDIRA with a proper custodian allows pretax contributions and mostly postpones taxes until retirement. You can read more about this topic here.
Wash Sale Rule
There is a second, possibly even more important piece of crypto tax changes in the Build Back Better plan. While still pending, this change could affect any active digital currency trader. It seeks to end crypto “wash sales.”
A wash sale is when someone sells a stock or bond to record a loss (in order to write off a portion of their taxes) and then immediately buys that same (or a similar) stock or bond again after the sale. In essence, you maintain ownership of the same asset and have a loss to offset trading gains.
This is a settled rule for most investments, like stocks and bonds.
However, there was a loophole for the newer crypto world. The “wash sale rule” only applies to investments listed by the IRS as “securities.” As of now, virtual currencies aren’t classified as securities. They are considered property.
So, the wash sale rule hasn’t applied for the likes of bitcoin and ethereum transactions. The Build Back Better plan intends to add cryptocurrencies to the list of wash sale rule “securities,”putting an end to crypto wash sales for good.
Cryptocurrency in the Eyes of the IRS
Despite being able to provide a full and complete picture of what it expects from cryptocurrency traders, the IRS has become increasingly active in pursuing those who left those trades off their taxes in years past. And in 2022, you can expect an even more aggressive hunt for crypto tax dodgers.
Over the past year, the IRS began one such hunt nicknamed “Operation Hidden Treasure.” This IRS investigation searched for crypto transactions that were left omitted from previous tax returns. Agents trained specifically in cryptocurrencies of all kinds made up the IRS teams working on this project.
This is just the latest of operations intended to track down “omitted” crypto trades. The IRS has increased its efforts over the past few years and we can expect the trend to continue.
While the IRS hunts and investigates missing crypto tax payments, how they calculate the taxes due is a different story altogether.
The IRS classified all cryptocurrencies as property starting in 2014. However, this broad definition and what investors ought to do about their own individual transactions in virtual currencies left much open to interpretation.
In short, the only answer the IRS gave regarding that classification was that anyone holding crypto for less than a year before selling it would need to consider any profits from it to be taxed as ordinary income. Those who have held for longer should consider any profits to be capital gains or losses and reported as such.
Events such as hard forks, airdrops, and mining had been completely ignored and left in confusion. Finally, after some pressure from Congress in 2018, the IRS began considering these situations in more detail.
In October 2019, the agency put out Revenue Ruling 2019-24. In this brief guidance, the IRS addresses two of the more technical problems it has had with reporting of cryptocurrencies–
- Hard Forks – When changes to a blockchain force a split, where the old chain continues but a new chain is created.
- Airdrops – When new coins or tokens are given to addresses of another chain.
Learn more about hard forks and airdrops here
The IRS ruled that hard forks without any airdropped coins or tokens are not taxable events because they don’t result in any gross income. This is a change from the previous stance that all events are taxable.
However, hard forks that include airdrops of the new chain or cryptocurrency do result in gross income—or “an accession to wealth”—as a tradable good with value was created. The fair market value at the time of the airdrop is used as the owner’s basis.
Hard forks and airdrops are somewhat rare. But this ruling does indicate that the IRS is looking at cryptos more seriously as potential sources of income to tax, and as such examining all of the situations that might arise for tax-paying virtual currency holders.
One Notorious Question
Virtual currencies made their way onto an official form starting with the 2019 tax year. At the top of the Schedule 1 for Form 1040, Additional Income and Adjustments to Income, this question appears: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
No doubt, checking the wrong box would look bad in the event of an audit. And that too is another recent subject worth noting.
After a full year of confusion, the IRS attempted to clarify what transactions demand a “yes” answer. In December 2020, the IRS put out a statement declaring that taxpayers need to answer “yes” even if they purchased a cryptocurrency and haven’t yet sold it.
Additionally, trading one crypto for another requires a “yes” check even though that too doesn’t constitute a “taxable event.”
The only time you can own crypto without needing to check “yes” in your 2021 taxes is if you bought it before 2021 and held it throughout the whole year without any additional transactions in the calendar year. Again, hard forks resulting in airdrops would also require a “yes.”
Despite all of this, there is still plenty of confusion about certain aspects of how cryptocurrencies are supposed to be taxed. You can read all of what the IRS has officially noted on the subject here.
Filing and Paying Taxes on Cryptos
Even though the IRS seems to be active in both its classification and enforcement of cryptocurrencies, not much in terms of actual tax rules has changed over the last few years. Cryptocurrency is, after all, still considered property.
In general, cryptocurrency is treated the same as any other investment you might own or sell throughout a year. If you bought a stock for $10 in January and sold it for $15 in December, you made $5 in ordinary income. If you bought that stock in the year prior, that income would instead be considered a long-term capital gain and taxed as such. Cryptocurrency is treated the same way for tax purposes.
This is most often viewed as the IRS attempting to persuade people into thinking of cryptocurrencies as long-term investments rather than quick trades. The rules do get a tiny bit trickier, though.
If you use cryptocurrencies like Bitcoin as actual currency (receiving or giving it as payment for something), that’s considered a taxable event. For business owners who accept crypto as a payment option, as well as those that choose to use it as an actual currency rather than an investment, this can cause a headache since each transaction, no matter how small, needs to be reported on annual taxes. That’s like trying to document every can of soda, cup of coffee, and bag of chips you bought in a 12 month period in your year-end tax forms.
The way taxes work when you use cryptocurrencies like regular currency is all dependent on how long you hold the coins or tokens. If you receive crypto for goods or services rendered, that’s easy—it counts as straight-up ordinary income and falls into that category for taxes. If, on the other hand, you paid someone with bitcoins or the like, you have some work to do. You need to figure out exactly when you obtained or purchased those coins originally. If it was less than a year ago, any change in value is considered ordinary income. If your original purchase was more than 12 months ago, that’s the same as cashing out a long-term profit or loss in the eyes of the IRS and therefore gets taxed as capital gains.
Keeping track of every transaction can be a real pain. Thankfully, there are ways to prepare for these tax hiccups ahead of time. Signing up for a specialized tax and transaction tracking app, software platform, or website can help. These are in addition to or as an alternative to setting up a simple spreadsheet of your own.
“Use an automated tool like CoinTracker to keep track of your gains and losses. This not only helps you calculate gains and losses, but also fulfills your substantiation requirements by having all your source data in one place… If you are buying crypto for the first time, make sure you track gains and losses for tax purposes and report them even if you don’t get a 1099 form at the end of the year.”
– Shehan Chandrasekera, Head of Strategy – Tax at CoinTracker.io, cryptocurrency portfolio tracker and tax calculator
In truth, you’ll only need to keep track of purchases or dates you received your cryptocurrency and dates when you sold or spent it, along with amounts of the transactions. The gains or losses accrued in periods of less than 12 months is “other income” come tax time. Those accrued over 12-plus months are “capital gains or losses” on your tax form.
There are other “taxable events” you must be aware of when it comes time to fill out your tax forms. In fact, there are four types of transactions that count as “taxable events” and must be reported each tax year (and two “events” that are not.)
- Cryptocurrency into Fiat — Whenever you sell a virtual currency in exchange for USD or other fiat currencies, this creates a taxable event similar to selling a stock for cash.
- Crypto into Another Crypto — Trading one virtual currency like Bitcoin into another like Ethereum is considered disposing of the original asset. So, be aware that the IRS requires you to report any gains from the first crypto. You will then use this price as your cost basis for your new crypto holding.
- Crypto into Goods and Services — As noted, whenever you pay for any item with cryptocurrency, the IRS considers this the same as if you sold it on an exchange. This is an annoying but important distinction that needs to be reflected on your tax forms.
- Earning Crypto — Mining new crypto, staking, and receiving an airdrop of new crypto requires reporting come tax season. This is considered an “accession to wealth” as indicated by the IRS in 2019. And as mentioned, this could also result in the need to issue your own 1099-B forms starting in 2023.
There are two types of transactions that don’t require reporting (though they may require you answer “yes” to the Form 1040 question).
- Buy and Hold Crypto — If you simply purchase and hold cryptocurrencies, you aren’t yet liable for taxes on them. Only when selling or trading out of them do you have to report gains or losses.
- Transfer Between Wallets — As long as you don’t actually sell or trade into a new crypto, the mere transfer of the same crypto between wallets is not a “taxable event.”
David Kemmerer, Co-Founder & CEO of CryptoTrader.Tax has an excellent breakdown of these taxable vs. non-taxable events here.
Caveats To Keep In Mind When Planning For Taxes on Cryptocurrency
The largest and most important caveat to consider is virtual currencies in self-directed IRAs, which allow for cryptocurrencies investments.
Cryptocurrency in an IRA makes a lot of sense, even from a tax perspective. Since the taxes on the gains and losses won’t come until retirement or when a Traditional IRA is cashed out, it is said that transactions within the IRA are tax-deferred. Trading cryptocurrencies inside, therefore, doesn’t create immediate taxable events for these types of IRAs.
Self-directed Roth IRAs reverse this. You do pay taxes on contributions to those. But any gains on your cryptocurrencies throughout the lifespan of that Roth IRA aren’t taxed as long as you wait until retirement to begin taking contributions.
The most important aspect to understand here is fees. With this being such a new subsector of the IRA world, making sure you know which fees you’ll need to pay and when is important.
Other caveats you should be aware of with cryptocurrency and taxes are:
- Be Mindful of Holding Periods – While we all know cryptocurrencies can move pretty fast, the tax consequences between holding for 365 days and 364 days is significant. The IRS considers the day after you acquire an asset or property (in this case coins or tokens) to be the first day. That calendar date in the following year marks the difference between short-term and long-term capital gains according to the agency. Be aware of your dates as you document your holdings and prepare your taxes.
- Don’t Forget Your Losses – Just like any other property or investment, cryptocurrencies go up and down in value. The IRS acknowledges that. Losses taken on cryptocurrencies can be written off, although the limit on this is $3,000.
- Keep One Eye Always on the IRS – With new rules possible any time, periodically checking in on the IRS’ virtual currency documentation will keep you in the loop. This is the central source of truth for all official IRS rulings on virtual currencies.
- Checking in With Experts – Of course, it never hurts to consult an expert. With cryptocurrency regulation and tax situations rather nebulous, a five-minute chat from time to time with a CPA with experience in cryptocurrencies won’t hurt. Check out our crypto CPA directory if you need help filing taxes with cryptocurrencies.
At BitIRA, our Digital Currency Specialists can help you set up a cryptocurrency self-directed IRA providing you with all the tax benefits of conventional IRAs. SDIRAs significantly minimize not just taxes but reporting requirements on your digital currencies. Your nest egg is yours to invest as you see fit, and an SDIRA gives you the power to do just that.
Call our team at BitIRA today to get started– (800) 299-1567.