The taxing side of cryptocurrency

With a global crypto market cap of $989.34 billion and a trading volume of $89.07 billion, the tax market size for the cryptocurrency and NFT market is substantial. This article sheds light on cryptocurrency taxes, sharing taxable and nontaxable transactions, crypto tax market size, and calculating taxes on cryptocurrencies, and answers to common questions about cryptocurrency taxes.

Taxable transactions

Cryptocurrency is taxed when the token or coin is used as a method of exchange. Generally, taxes may be imposed on the following scenarios:

• Selling the cryptocurrency tokens or coins.
• Exchanging the crypto with a fiat currency or another cryptocurrency.
• Paying for services using a cryptocurrency.
• Receiving forked or mined crypto.

Furthermore, taxes can be imposed on NFTtransactions and the creation or minting of NFTs. Let’s see which NFTtransactions may be taxed:

• Purchasing and selling of NFTs on digital marketplaces is an exchange and is taxed.
• Taxes are imposed on paying gas fees to mint NFTs.
• Selling an NFT for cryptocurrency or exchanging it for another NFT is also taxable.
• Any royalties earned for created NFTs are taxable.

Nontaxable transactions

The taxes on cryptocurrencies are easy to calculate if you understand the fundamentals. There are four areas where you may not need to pay any taxes, depending on the state/country you live in or where the transaction has been performed. These scenarios may include:

1. Purchase of any cryptocurrency using a fiat currency such as the U.S. dollar, euro, and more.
2. Holding said cryptocurrency on the exchange.
3. Transferring the cryptocurrency to a personal wallet.
4. Giving cryptocurrency as a gift, within threshold limits, or donating it to a tax-exempt or charitable organization.

Understand how crypto is taxed

The IRS generally considers gains on cryptocurrency transactions the same as any other types of capital gains. Let’s understand how crypto is taxed and how it could be reduced.

How to calculate tax on crypto

Cryptocurrency is taxed between 0% and 37% for 2022. Individuals should note that the IRS counts short-term cryptocurrency gains as ordinary income. On the other hand, the amount of tax will vary if you hold any cryptocurrency or NFT longer than a period of one year.

The IRS also allows the deduction of capital losses; individuals can claim a loss if the value of their cryptocurrency goes down. Individuals need to report crypto taxes on Form 8949, Sales and Other Dispositions of Capital Assets, by providing the cryptocurrency asset, dates of acquisition and trade/disposal, proceeds, cost basis, and total gain/loss.

Taxpayers need to create a perfect log throughout the year, noting the details of each transaction. There are dozens of cryptocurrency tax-tracking applications that do the heavy lifting of calculating gains and losses.

Manual tracking is likely to have errors and omissions. Given that many cryptocurrency users generate hundreds and thousands of transactions per year, a tax-tracking app is essential to accuracy.

But here’s the caveat: They all provide different answers.

You can test this reality across two or three different platforms to understand the ambiguities that are inherent in tax calculations.

At best, expect to have a range of acceptable calculations. Unfortunately, there is no “right” answer, only a range of answers.

In May 2022 the IRS partnered with Zenledger to help their organization determine the “right” answer when it comes to crypto taxes. In the upcoming tax seasons we’re likely to see clarity and best practices emerge to tighten the range of acceptable calculations.

How to reduce crypto taxes

Common methods individuals can research to reduce crypto tax liabilities include:

• Tax-loss harvesting, in which your cryptocurrency losses can be used to offset other crypto or stock market gains.
• Making long-term investments for lesser capital gains tax rates.
• Taking profits in low-income years.
• Working with a knowledgeable tax advisor familiar with cryptocurrency and tax-saving strategies.

Proactive planning can also mean placing a portion of profits back into fiat or a stablecoin, to ensure the taxpayer has the funds available to pay the tax bill if gains are substantial.

Otherwise taxpayers may be in a situation where during a bear market they may have to liquidate their entire portfolio to pay their tax bill. This is a common situation that is likely to increase as more taxpayers engage in cryptocurrencies without a tax strategy.

Given this reality, here are a few questions that tax advisors should ask clients before filing their crypto taxes:

1. Has the client purchased, sold, or traded in cryptocurrencies or NFTs?
2. Is the client active in DeFi?
3. How does the client keep track of all the transactions?
4. Does the client accept cryptocurrency payments for their business?
5. Does the client earn profits via cryptocurrency mining?
6. Does the client pay their workforce via cryptocurrency?
7. What’s the client’s tax strategy?

Even with clearly defined guidelines and distinctions between taxable and nontaxable crypto-involving events, much can go wrong. Individuals and tax advisors must stay aware of the nuances to file taxes with the best precision possible.

Editor’s note: This is an excerpt from Sonia Dumas’ Cryptocurrency Guide. Download the guide here.