Don't say it! Don't say the "T" word! Ok, I must admit, this is an article that I have been dreading writing and I have put off time and time again, but taxes are my least favorite thing in the entire world. Big thanks to Ray B. for requesting this topic & lighting a fire under my arse! Taxes are always hard to swallow and unfortunately the US Government wants to tax your Bitcoin as well. Follow along as I break down how to deal with cyrptocurrencies and taxes in the US in a simple and easy to understand way.
Convertible Virtual Currency
As defined by the IRS in 2014 with their document Notice 2014-21 (linked here), Bitcoin and other cryptocurrencies are considered "property" and not a currency by the US Government. That means that every Bitcoin transaction you make can pretty much be taxed. Depending on how you use it, the way it is taxed also changes. If you use it on the daily, paying for goods & services, you are in for a record keepers nightmare. If you buy and hold your Bitcoin and then take out some profits there is less to keep track of, but you still get taxed. Bitcoin is considered a "convertible virtual currency" by the IRS which in their terms means;
"Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency."
With the IRS defining cryptocurrencies as "property" and not a currency it really makes it a hassle to use cryptocurrency for anything without recording every individual tax implication. Well played US Government... well played.
I will break down each individual situation on paying your Bitcoin taxes below which I break down into 4 categories.
Trading & Cashing Out = Capital Gains
Bitcoin and other crypto's are treated as Capital Gains if you are cashing them out to USD or exchanging them for other cryptocurrencies. Here are the scenarios broken down:
- Trading Bitcoin for another cryptocurrency = Short Term Capital Gain or Loss and is subject to your Ordinary Income Tax Rate like you would pay on any other income.
- Cashing out Bitcoin for US Dollars = Short Term Capital Gain or Loss and is subject to your Ordinary Income Tax Rate like you would pay on any other income.
- Cashing out or trading Bitcoin after holding it longer than a year = Long Term Capital Gain or Loss and is subject to a different tax schedule.
The last one is what stuck out to me. If you hold your Bitcoin for longer than a year you get subject to a different tax rate. You can see the whole schedule below, but if you notice, people that make less than $37,950 a year are charged 0% tax! Now of course you have to include the capital gain in that calculation, but still. For most people they will still have to pay 15% tax though.
Getting Paid In Bitcoin
Bitcoin payments from an employer are also taxable just like any other source of income.
- You must convert the Bitcoin to a dollar amount when you receive it and make a record of the amount.
- Bitcoin earnings need to be included on your w-2 as well.
- Self-employed individuals are also included.
- When sub-contracting, if the payment is more then $600 in value it must be reported.
Merchants Accepting Bitcoin
The assumption is merchants that accept Bitcoin or cryptocurrencies are converting them right away to US Dollars because they are not in the business of taking on the risk of holding Bitcoin. While I don't agree at all with this, any items or services you sell in exchange for Bitcoin are also taxed as normal income.
- Still need to charge sales tax if it applies in your area
- You need to get w-2's from any contract that you pay more then $600 worth of crypto to
- Everything must be converted to dollars to report it. This is the worst aspect of reporting in my opinion
Bitcoin Mining Tax Rules
Guess what? It's taxed too! The government always wants it's cut! You must pay tax on the fair market value of the Bitcoin on the day you mine it. This is still a tricky area when it comes to taxes, but just know that yes you are supposed to report all gains from mining cryptocurrency as well.
Tips & Resources
So now we know that pretty much anything you do (except hold and never sell!!!) with cryptocurrency is going to be taxed by the US Government. Of course the thing with cryptocurrencies is that they are not easy to track and also not well regulated. From my experience the IRS is pretty lousy with regular tax issues, I doubt they would be any more diligent pursuing those that did not report their cryptocurrency gains (not advocating you do this though!). So if we have to report it then we have to track it and keep amazing records. Here are some tools to help:
Cointracking - This is hands-down the best site to track and automatically generate a detailed report for your cryptocurrency taxes. They connect with the most exchanges and wallets by far and make it super simple to file your crypto gains, losses, gifts, mining, etc.
Coinbase - If you use Coinbase you can generate a "Cost Basis for Taxes" report from the dashboard that helps with calculating your tax based on your account. This is basic info and not super complete, but a good start for sure.
PayByCoin add-on for Quickbooks - A plugin for merchants to accept payment via Bitcoin and reconcile the data inside the online version of Quickbooks.
Most transactions are taxable when it comes to Bitcoin and it just depends on how you use it. In general keeping good records should be enough to suffice the tax man when he cometh. Holding Bitcoin & cryptocurrency longer than a year seems to be the best strategy here and if you are like me you are already going to be holding for the long term and not cashing out a ton. There are some good resources to help you in tracking, but isn't one of the best things about cryptocurrency the veil of (mostly) anonymity? A scene from the movie Catch Me If You Can comes to mind, but it soon fades as the thought of tax season dances in my head...