The IRS is cracking down on cryptocurrency tax reporting. As digital currency trading becomes more mainstream, the government is on the lookout for tax evasion. If you are an individual or business you need to be aware of the tax implications of crypto investments. Here is your guide to filing Form 8949 for cryptocurrency gains tax, crypto payroll tax, and ordinary income tax.
In this article:
- What is cryptocurrency: fiat vs digital currency?
- Crypto tax: What makes cryptocurrency a taxable event?
- Filling out Form 8949
- Loss-harvesting cryptocurrency gains
- Crypto payroll: How businesses pay crypto taxes
What Is Cryptocurrency?
Alternative currencies have come and gone, but none have been as promising as cryptocurrency. In 2009, Satoshi Nakamoto, an elusive programmer—or group of programmers—launched bitcoin, a virtual currency that could be exchanged anonymously. The currency exchange happens through a decentralized network meaning no person or group controls the transaction. What makes this digital currency different is cryptography and blockchain technology.
For Example: a bitcoin is purchased, it is encrypted with digital keys from the sending wallet to the receiving wallet. The digital key is called cryptography, hence the name cryptocurrency. While floating in the ether, the money is recorded on a digital ledger called the blockchain. The ledger does not know who is on either end of the transaction because user computers around the globe link tiny blocks of data to the chain to complete the transaction.
Fiat vs Digital Currency
The U.S. economy runs on a fiat currency system with paper and coin notes. Dollar fiat currency used to be redeemable for gold and silver but due to factors like the scarcity of precious metals, rising U.S. inflation, and war debts, the American treasury stopped promising gold or silver-backed notes. Now, the dollar is backed by the U.S. treasury; guaranteed by trust in the stability of the U.S. Government and its economy.
Digital currency or cryptocurrency is a trustless system. No government can destabilize the network; it is supported by all of its anonymous users. These users do complex computing to finalize transactions, but no one controls the exchange of money. Since blockchain technology has yet to be hacked, it is a solid structure for trade.
While bitcoin was under the radar, early investors took advantage of a cashless tax-free lifestyle. Unfortunately, its transactional anonymity became a breeding ground for illicit activity, putting it on the federal government’s radar.
Now, the IRS regulates gains on virtual currency investments and considers trading and selling taxable. The rules regarding taxation are relatively nuanced so here is what you need to know.
Currency Trading Taxes vs Cryptocurrency Tax
Fiat currency trading taxes are different and apply to exchange rates, options, and future buys. Cryptocurrency is NOT subject to traditional currency trading taxes.
Cryptocurrency is treated in two ways by the IRS:
- As property, subject to capital gains tax
- As ordinary income at fair market U.S. Dollar value, subject to income tax
What Makes Cryptocurrency A Taxable Event?
The sale or disposal of virtual currency is a taxable event. Once the sale is final, it is taxable because it is a “realized” capital gain/loss. Even if you don’t cash out after the sale, and the money sits in a wallet, you are still responsible for taxes.
There are 4 taxable events that the IRS tracks:
- Crypto to fiat currency trade
- Crypto to crypto trade
- Crypto to a tangible item purchase
- Crypto reward to fiat currency trade
Form 8949 Cryptocurrency Tax Reporting
All cryptocurrency events are reported on a Schedule D with the accompanying Form 8949. If you are trading on an exchange that sends out Form 1099-B, it will be easier to file your taxes. Despite the increasing IRS scrutiny of cryptocurrency gains, there are still many exchanges that don’t provide sellers with consolidated tax information.
If you are working on an exchange that does NOT provide tax forms, you have to do the leg work. You will need to attach a .pdf document of your taxable crypto investments to your tax return.
Compiling your trading information can be done in one of 3 ways:
- Download your trades into a .csv or .pdf spreadsheet from the exchange, manually add up gains and losses on Form 8949.
- Pay a company like Koinly or Crypto Trader Tax to integrate your trading spreadsheet into your tax software, so Form 8949 is automatically filled out.
- Get in touch with us, we manage all the fine points of capital gains income for businesses.
Crypto Capital Gains Income
Buying, selling, and trading crypto is, by definition, investing activity. You are only going to be taxed on profitable events. All profits from investing in crypto are considered capital gains income and are taxed accordingly.
Capital Gains: when you make money off a sale.
Losses: when you lose money from a sale.
Wash Sale: there was no gain/loss.
There are two types of gains: short-term and long-term. These state how long you held the investment in the market. You pay more for a short-term capital gain because they are sold within a year. Short-term gains are taxed depending on your overall income and follow the income tax brackets of 10-30%.
If your holding period was longer than a year it is considered long-term. The IRS incentivizes traders with reduced tax rates for long-term gains. Long-term tax rates follow income tax brackets but are discounted, ranging from 0-20% of capital gains.
What Documents Do I Provide To Prove A Cryptocurrency Loss?
Losses are considered deductions, so don’t leave them unreported. They help to offset your crypto gains. If you receive a 1099-B your losses will be declared for you to report on your taxes. If you have to download your trading data, include the spreadsheet in .pdf format. Manually calculate your short-term and long-term losses, on Form 8949 for cryptocurrency.
What Is A Wash Sale?
The wash sale rule is for short-term concurrent sales that equal no capital gain or loss. This is when you purchase stock and sell it shortly after, then you repurchase that same amount of stock.
For Example: If you buy Apple stock on the first of the month, on the 15th you are losing money so you sell it. If you repurchase the same amount of Apple stock at the end of the month, it is considered a wash.
A wash sale is never considered long-term investing. It is only used for trading activity happening within 60 days. The IRS implemented this rule to combat loss harvesting, which reduces capital gains tax.
How Do I Report A Crypto Wash Sale?
Since digital currency is taxed as a property, the wash sale rule does NOT apply. Form 8949 for cryptocurrency is only used to report capital gains and losses. Unless tax regulation changes, there are NO crypto wash sales.
Loss Harvesting Cryptocurrency Gains
Tax-loss harvesting is a strategy to deduct losses against cryptocurrency gains. Traders will sell off a certain amount of crypto to offset gains. For this tax strategy, you take a monetary loss and risk a market price change. You CANNOT claim a loss if you repurchase the same crypto within 30 days.
For Example: this year you have a tax gain of $50,000 because you purchased 1 Bitcoin at $10,000 and sold it at $60,000. To offset capital gains tax you sell 10 Ethereum for a total of $17,000. You originally purchased them for $35,000. Now you have a loss of $18,000 that you report to the IRS to reduce your tax liability for the Bitcoin gain.
Filling Out Form 8949
DIY taxes anyone? Filling out Form 8949 for cryptocurrency is easy once you get the hang of it, but will take some good ol’ time and patience.
We will go through the main parts so you can record each sale accurately. Use the Form 8949 example above to fill out the following information:
Description (a) = Enter the exact value of virtual currency sold plus the full name and/or the abbreviated symbols
Date Acquired (b) = Date the crypto was purchased, traded, gifted, or inherited.
Date Sold (c) = Date the crypto was sold. If it was a short sell, put the date you gave the crypto to a lender.
Proceeds (d) = How much you sold the digital currency for in U.S. Dollars. Total all sales at the bottom of the worksheet.
Cost (e) = How much you purchased the digital currency for in U.S. Dollars, plus any fees or commissions. Total all purchases at the bottom of the worksheet.
Gain or Loss (h) = Show the difference between your Cost and your Proceeds. All loss values should be reported with a parenthesis. Total all gains and losses at the bottom of the worksheet.
Codes and Adjustments (f) and (g) = It is rare that you will need to report an adjustment to your gain or loss, a 1099-B would detail this information.
How To Do FIFO Accounting For Cryptocurrency?
For tax purposes, you have to specify a sale to a buy. You can use the First In First Out (FIFO) method when you have limited trading activity to report. FIFO accounting for cryptocurrency means your first buy is attributed to your first sell, and you calculate the difference between the two to report a gain or loss.
In the crypto world, it is common to see hundreds of buys and sells. How do you do FIFO accounting for cryptocurrency then? In this scenario, you record “Various” as the date acquired for multiple buys, and you calculate the difference between the total buys and total sales.
How To Avoid Paying Taxes With Cryptocurrency Gains?
You should never avoid paying taxes. If the exchange you are trading with is compliant with the U.S. Government, then the IRS is aware of your activity. If your exchange does NOT comply with the IRS, you still need to pay taxes with cryptocurrency gains because you could get penalized for not reporting.
Cryptocurrency Ordinary Income Tax Reporting
Many companies are incorporating cryptocurrency into compensation plans. In this case, digital currency is taxed as ordinary income. Here are the crypto payroll tax implications for businesses and individuals.
Crypto Payroll: How Does It Work?
Crypto payroll processing has blockchain security in place for identity protection. They can pay employees faster including any international workers; use a single form of currency to pay a globalized workforce; minimize bank fees with wallet-wallet transfers; get the leading edge on a tech-savvy labor force by offering enticing perks.
Companies generally pay employees with stable coins. These are virtual currency coins that have a fixed value ratio with the dollar. Since labor laws are vague about the legality of paying in cryptocurrencies, many businesses offer mixed compensation with digital and fiat currency.
Note: It is highly recommended you stay updated with state labor laws on crypto payroll.
How Does A Business Pay Crypto Taxes
The rule of thumb—all digital currency needs to be converted into a common currency.
- Business Tax Reporting – Paying for services with crypto, means you have exchanged a service for an asset. You will need to report the service payment as a capital gain or loss. Your gain or loss is based on the fair market value of the service.
- Payroll Tax – Withheld in the same manner but converted to U.S. Dollars and paid to appropriate governing agencies.
- Forms To Send Employees – All forms should be converted into dollar value or common currency. Use Form W-2 for all salaried wages; Form 1099-NEC for contract work; Form 1099-DIV for a distribution.
Pro Tip: For corporations, digital compensation needs to clearly be labeled as a salary or distribution and not a dividend disguised as a salary.
How Does A Business Report Income Earned From Cryptocurrency?
Depending on the business you will use different tax forms. Here are the most common situations for reporting.
- Bitcoin Mining – If it is a self-employment venture it is reported on Form 1040 Schedule C
- Crypto Deposits or Interest – If a business is earning revenue from digital currency interest, for pass-through entities it is going to be reported on Schedule 1 as Other Income.
How To Pay Taxes On Digital Currency Earned As Income
You could end up paying taxes twice when getting paid for services in cryptocurrency. First, it is taxed as ordinary income, based on when you receive the digital currency payment in a wallet (before cashing out). To file your income return you convert digital currency wages into fair market value U.S. Dollars, on the date of payment. It will be taxed according to standard income tax brackets.
That crypto payment for services is also your cost basis in the crypto or rather your starting price for capital gains tax. You will only pay additional tax on gains above the income received.
For Example: You were paid .1 BTC for a contract around $6600 at the time the payment was received. On your income tax return you report this payment and will be taxed according to your tax bracket. You kept it in a wallet for a year and then cashed out at .13 BTC or $8600. You will need to pay long term capital gains tax on the profit of $2000.
Once you sell your crypto, for U.S. dollars, it is considered a realized capital gain/loss. So you must report the capital gains income, as detailed earlier in the article, on Form 8949 for cryptocurrency. Depending on when you sell it determines whether it is a short-term or long-term gain.
Note: If you are paid with a stable coin, at a 1:1 conversion ratio, capital gains tax won’t be too much of an issue.
Due Diligence: Digital Currency Taxes
It is so important to do your taxes, even more so if you’re investing. The IRS is really happy to collect penalties, and they are sniffing out the cryptocurrency high rollers. If you need help preparing and filing your investments, our tax experts will guide you through the proces