The Internal Revenue Service (IRS) recently said it is in the process of mailing 10,000 educational letters to taxpayers it suspects owe government taxes on virtual currency transactions. The federal agency may well have based its recipient list on customer data it acquired from crypto currency exchange Coin base. Those who do not report their income correctly can face penalties, interest, or even criminal prosecution, the IRS warned.

Bitcoin and taxes

Although originally proclaimed anonymous, the majority of Bitcoin transactions today are transparent. Governments have observed waves of illegal market trading using Bitcoin in the past. Exchanges are now imposing anti-money laundering requirements on Bitcoin traders to avoid provoking the ire of regulators.

However, the biggest change for Bitcoin traders has been taxes.

While regulators, central bankers, and federal judges have differing opinions on how to categorize Bitcoin, whether its a currency or a commodity, they all seem to agree that it should be taxed. Most major countries also tax crypto currencies in a similar way.

So what does that mean?

The specifics

The first thing to know is that nothing matters until it is enacted. There is always speculation about what will happen based on what some financial regulator says, but no one has the ability to redefine an asset or unilaterally alter the tax code, and little has changed since the IRS first addressed crypto currencies in 2014. .

In the United States, IRS Notice 2014-21 defines virtual currencies as property. This means that anything purchased with a digital currency can be taxed as a capital gain, either short-term or long-term, depending on how long the asset was held.

For example, if you buy a cup of coffee with Bitcoin that you bought when it was worth $ 1,000, you must also take into account the price of Bitcoin at the time of purchase of the coffee. If Bitcoin is trading at $ 1,200 when you buy the coffee, you have bought a dollar-denominated good with another asset that is now worth more in dollars than it used to be. That means the amount of Bitcoin you spent on the coffee will be taxed according to the capital gains rules.

While crypto brokers are not required to issue 1099s to clients, traders are supposed to disclose everything to the IRS or face tax evasion charges. Taxable transactions include:

Exchanging crypto currencies for fiat money or “cashing in”

Paying for goods or services, such as using Bitcoin to buy a cup of coffee.

Exchange a crypto currency for another crypto currency

Receive mined or forked crypto currencies

The following are not taxable events according to the IRS:

-Buy crypto currencies with fiat money

-Donate crypto currency to a tax-exempt charity or non-profit organization

-Make a gift of crypto currencies to a third party

-Crypto currency transfer between wallets

How to determine what you owe

Determining how much profit you have made and how much you have to pay in taxes is a bit tricky.

Cryptocurrency collection

According to standard tax rules, when charging crypto for fiat money like dollars, you need to know the base price of the Bitcoin you are selling.

For example, if you bought Bitcoin for $ 5,000 and sold it for $ 7,000 three months later, you will pay a short-term capital gains tax on the $ 2,000 earned. If the same transaction took place over a two-year period, long-term capital gains taxes are applied 

Selling the crypto currencies that one has mined instead of the ones previously bought with fiat money is a different story. Since they are receiving dollars in exchange for mining inputs that can only be described as work (and indeed it is by the term “Proof of Work”), the profits made from the sale of mined crypto currencies are taxed as ordinary income. You can also deduct expenses that went into your mining operation, such as PC hardware and electricity.

Personal shopping

Taxes on the purchase of a cup of coffee with crypto currencies are also complicated. You have to know the base price of the Bitcoin that they used to buy the coffee and then subtract it by the cost of the coffee.

Currently, the tax code allows taxpayers to exclude up to $ 200 per transaction for foreign exchange rate gain, if the gain was derived from a personal purchase, such as a cup of coffee. This is known as a de minimis election. But there is no de minimis clause exempting small transactions, which can create a complicated tax situation if one is constantly exchanging crypto currencies and also using them to buy goods and services.

 

Determining which currencies were used to purchase the coffee, their base price, and corresponding earnings, and then repeating this for each purchase only becomes more complicated if the buyer frequently exchanges currencies as well. Therefore, it is important to remember to keep all transaction information for each wallet and digital currency.

 

Another complication comes with the fact that this only works in case of gains. Reporting a loss and getting a tax deduction is relevant only for capital asset transactions or for-profit transactions. If you buy Bitcoin at $ 8,000 and then use it to buy a pair of jeans when Bitcoin is worth $ 6,000, you cannot report this as a loss on your tax forms.

Crypto currency exchange

The crypto currency exchange also exposes investors to taxes. You are effectively selling Bitcoin if you buy Ethereum with it, so you will need to report the difference in the price of Bitcoin between the time you bought it and the time you spent it on Ethereum, as well as taking note of the Ethereum price in the time of purchase for when you sell it later.

 

Many exchanges help crypto traders keep all of this information organized by offering free exports of all trade data, which an accountant can use to determine your tax liability. Blockchain solutions are also suitable for recording this data. 

Platforms like TrustVerse have smart contract-based wealth management services that organize digital identity and assets on the blockchain.

It is always recommended to seek a qualified tax professional assistance when preparing your tax return with crypto trading. For now, the IRS has published some guidance on how to prepare and amend tax returns involving crypto transactions.