The Tax Act of 2017 was approved by the Senate and signed into law in December. Some people mistakenly believe that this new tax legislation has caused them to be taxed on their cryptocurrency gains. That is not true, but it will take time for the IRS and other agencies to figure out how to deal with long-term cryptocurrency investments. To determine whether your taxes were impacted by cryptocurrencies last year, you should consult a qualified tax professional or read up on some of these major myths about taxation relating to digital assets such as Bitcoin, Ethereum, Ripple etc..
The “is cryptocurrency taxed” is a question that many people have asked. There are many myths about cryptocurrencies and taxes, but they are all debunked in this article.
Taxes and cryptocurrency may not be a perfect marriage, but they are unavoidable, and the US Internal Revenue Service (IRS) has made it plain that anyone who fail to file will be prosecuted. The IRS is on the prowl, with summonses issued to Coinbase, Kraken, Circle, and Poloniex, as well as other enforcement actions. The IRS issued 10,000 letters in various formats requesting compliance, but they were all nudges to persuade people to comply.
The IRS’s quest for cryptocurrency has been likened to the agency’s hunt for overseas accounts a decade ago. Unfortunately, it is unclear if a crypto amnesty scheme modeled after the IRS’s offshore voluntary disclosure programs will ever be implemented.
More IRS crypto reporting means more risk
In Notice 2014-21, the IRS issued the first major pronouncement concerning cryptocurrency, recognizing it as property. This has significant tax implications, which are exacerbated by price volatility. Selling cryptocurrency might result in a profit or loss that is taxed. However, even purchasing anything with cryptocurrency might result in taxation. Paying workers or contractors has the same effect. Even paying taxes in bitcoin might result in further charges.
The IRS and certain states (most notably California’s Franchise Tax Board) have already conducted crypto audits, and more will undoubtedly follow. At the very least, there are monitoring and tax return preparation options available that make the process simpler than it was before. Everyone is attempting to reduce taxable cryptocurrency profits and delay taxes whenever legal.
Even so, it’s simple to get perplexed about tax treatment and adopt tax positions that will be difficult to justify if you’re detected. With that in mind, I’ve heard a few things that I’ll refer to as crypto tax myths.
Unless you obtain an IRS Form 1099, you cannot owe any tax on bitcoin transactions. You may tick the box on your tax return that states you did not have any bitcoin transactions if you did not obtain a Form 1099.
Actually, even if the payor or broker does not submit a Form 1099, tax may still be payable. A Form 1099 does not produce tax where none was previously payable, and many forms 1099 do not record taxable income. If a Form 1099 is incorrect, you must explain it on your tax return. However, if you’re audited and your best justification is that you didn’t disclose your transactions because you didn’t obtain a Form 1099, it’s a poor case.
You don’t have to report your cryptocurrency on your tax returns if you keep it in a private wallet rather than an exchange.
Actually, the tax requirements are the same whether you use a private wallet or an exchange. The desire to conceal ownership by transferring assets to anonymous holding companies is not new. Many U.S. taxpayers tried everything when Swiss banks started identifying their U.S. accountholders to the IRS and the Department of Justice, but virtually everyone paid in the end, generally with large fines. The IRS Form 1040’s bitcoin question is not confined to cryptocurrencies owned via exchanges. Even if you have crypto in a private wallet, if you claim “no,” you may be making false statements on a tax return signed under penalty of perjury. You may wager that you’ll never be discovered, but thousands of US taxpayers with Swiss bank accounts can speak to how bad that gamble can turn out.
If you store your crypto in a trust, LLC, or other business, you will not owe tax on the transactions and will not be required to declare them. Furthermore, revenue made via LLCs is tax-free (the fallacy persists).
Actually, owning cryptocurrency via a company may allow you to deduct the revenue from your taxes. However, unless the company qualifies (and is registered) as a tax-exempt entity, it will most likely be subject to tax reporting and may owe taxes. Depending on their circumstances and tax elections, LLCs are taxed as corporations or partnerships for tax purposes. Because single-member LLCs are ignored, the LLC’s earnings land up on the lone owner’s tax return. If your business is a foreign entity, there are complicated tax requirements in the United States that might make you personally accountable for revenue generated by the foreign corporation.
I don’t have to declare the profits of my crypto sale if I arrange it as a loan (or any other non-sale transaction).
Actually, think about whether you’re lending or selling the cryptocurrency. Scam transactions are disregarded by the IRS and the courts under strict guidelines. Are you receiving the same cryptocurrency that you lent? Do you charge interest on the loan and pay tax on the interest as it comes in? Some loans may not be able to withstand the test of time. Furthermore, if you sell crypto and obtain a promissory note, your taxes may become much more complicated due to installment sale calculations.
Because you can’t modify the exchange’s regulations unilaterally, a crypto exchange is a sort of trust. For tax reasons, you do not own the cryptocurrency in your account, and you do not need to disclose transactions via an exchange.
Actually, none of this has been stated by the IRS. According to IRS guidelines, the IRS considers taxpayers to be the owners of the cryptocurrencies stored in their exchange accounts. It is exceedingly improbable that the IRS would regard crypto kept in an exchange account as belonging to the exchange (as trustee), rather than the account holder. Taxpayers often hold their assets via institutional accounts such as bank accounts, investment accounts, 401(k)s, and IRAs.
In most situations, the tax law considers taxpayers to be the owners of the funds and assets stored in these accounts. Special accounts, such as 401(k)s and IRAs, have unique tax requirements. Furthermore, treating an account as a trust does not always result in a favorable tax outcome. Beneficiaries of trusts, especially foreign trusts, are subject to onerous reporting requirements. Thus, be cautious what you want for before considering crypto exchanges as trusts. The fact that something is called a trust does not imply that the revenue earned inside it is tax-free.
Crypto-to-crypto transfers are not taxable as a result of Congress’s revision to Section 1031 of the tax law, which confines like-kind swaps to real property.
Actually, a taxable gain arises from the “sale or other transfer of property,” according to Section 1001 of the tax law. A taxable gain may result from the selling of any sort of property for cash or other goods. According to the IRS, cryptocurrency is property, thus selling cryptocurrency for cryptocurrency is a sale of cryptocurrency for the value of the new cryptocurrency.
A crypto-for-crypto swap would have been acceptable as a like-kind exchange before the Section 1031 modification took effect in 2018. However, in tax audits, the IRS is challenging this stance and has issued instructions denying tax-free status for some cryptocurrency transactions. That isn’t a precedent, and it doesn’t cover the waterfront, but it does provide you some insight into what the IRS is thinking. In any event, crypto-to-crypto exchanges are taxed unless they qualify for another exclusion since that Section 1031 has confined like-kind exchange treatment to actual property.
Every taxpayer has the right to organize their activities and transactions in order to reduce their tax burden. Quick cures and hypotheses that seem too wonderful to be true should be avoided. The IRS seems to feel that many crypto taxpayers are breaking the law, so being cautious in the future and cleaning up the past are worthwhile considerations. Take care while you’re out there.
This article is meant to provide basic information only and should not be construed as legal advice.
The author’s views, ideas, and opinions are entirely his or her own, and do not necessarily reflect or represent those of Cointelegraph.
Robert W. Wood, a managing partner of Wood LLP in San Francisco, is a tax lawyer who represents clients all around the globe. He is the author of multiple tax books and contributes to Forbes, Tax Notes, and other publications on a regular basis.
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