Before the tax season ends , learn about cryptocurrency and if it affects your 2021 tax refund
TL;DR: The IRS treats cryptocurrency as property. It’s helpful to remember tax rules that also apply on stocks. If value goes up and the owner sells at a profit, they’ll likely pay capital-gains tax. If the value goes down and the investor sells at a loss, they get a capital-loss deduction.
Keep a look out for these 3 main points we’ll discuss in this article about cryptocurrency:
The world’s finances; the beginnings of cryptocurrency
The relationship between cryptocurrency and your taxes
When to report cryptocurrency (such as bitcoin trades) to the IRS and how
What does cryptocurrency have to do with your taxes? Should you wait to file your taxes because of this e-cash craze? Well, here’s a heading of an article published by the official CNBC website that could summarize the topic: “Failure to report cryptocurrency on your tax return can lead to trouble with the IRS.”
The IRS has put crypto front and center for this tax-filing season. High up on the first page of your tax return, a yes or no question is posed: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
This unique combination of digital money (cryptocurrency) and government demand (taxes) might sound intimidating at first. And we get it. It’s (relatively) new, conversations about money always have an air of intimidation to it, and we’re all in the midst of an economic crisis that’s lasted over a year. Intimidation might be an understatement.
But the idea behind cryptocurrency, in itself, is relatively simple: It’s an electronic cash system. And, according to Jan Lansky, a cryptocurrency system has to meet six conditions:
- The system does not require a central authority; its state is maintained through distributed consensus.
- The system keeps an overview of cryptocurrency units and their ownership.
- The system defines whether new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the circumstances of their origin and how to determine the ownership of these new units.
- Ownership of cryptocurrency units can be proved exclusively cryptographically.
- The system allows transactions to be performed in which ownership of the cryptographic units is changed. A transaction statement can only be issued by an entity proving the current ownership of these units.
If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.
The history of the world’s finances: Understanding the fluctuating socioeconomic status of the world; the beginnings of cryptocurrency
Created over a decade ago in the beginning of 2009, the first decentralized cryptocurrency, Bitcoin, was released as open-source software. Since then, other cryptocurrencies have been created.
With the e-cash craze appearing to not slow down anytime soon, we’re covering the basics of cryptocurrency, namely, those who have used cryptocurrency in 2020, have taken a general interest in cryptocurrency, or any passerby who happened to come across this article.
We know that the socioeconomic status of the world is constantly fluctuating. It always does. Back in 2010, one article said that “many of today’s families face significant financial problems as a result of the current crisis in the economy.” In fact, the article said the first decade of the new millennium (i.e., 2000-2009) had been one of “uncertainty and instability.”
This was over a decade ago, but doesn’t it sound eerily close to present world conditions? It sounds like we could plug that statement into a news publication tomorrow and everyone would praise it’s relevance.
As a result of the pandemic, people are curious about finances. Even you’re likely curiously concerned about money — your money, my money, the world’s money. Because another person’s money could affect yours, and the world’s money (or lack thereof) could also affect yours. Taxes is a primary example of this statement proving true.
What is the relationship between cryptocurrency and YOUR taxes (Is there a relationship)?
Going back to the headliner we quoted at the beginning of this article, the IRS has made it pretty clear that if you fail to report cryptocurrency on your tax return, you could get in trouble.
The article brings out three key points to look out for:
The IRS has put a question about cryptocurrency holdings on page one of 2020 tax returns that taxpayers are expected to answer accurately.
If you had income from crypto — whether due to selling at a profit or receiving a digital asset for work performed — failure to report it could come back to bite you.
“It could be a real tax mess for folks who try to hide crypto earnings from the IRS,” said certified financial planner Kathryn Hauer.
The article continues:
Regardless of how you interacted with any cryptocurrencies last year, you’re expected to include the information on your 2020 tax return. And for those who had income from virtual currency — whether due to selling at a profit or getting paid crypto for work performed — failure to report it may haunt you.
Words like “trouble” and “haunt” aren’t the most inviting, but we don’t think the IRS is trying to make the topic of cryptocurrency and taxes a jovial one; it’s something they’re clearly taking seriously, and they want us to do the same.
But the reality is that crypto earnings are just as tangible to the IRS as physical earnings; banknotes, metal coins, checks are all just as taxable as electronic currency. So if you try to hide crypto earnings from the IRS, it could be just as bad as trying to hide earnings from checks from the IRS.
The bottom line: Money is money, no matter what form of money it’s being received in. And no matter how it came into your possession, you are expected to tell the IRS about it.
Why the interest in cryptocurrencies? Well, they keep achieving a progressively higher profile. In February, bitcoin hit an aggregate value above $1 trillion. So as more people eye cryptocurrencies, more people have to face up to the tax rules at play.
For more information on bitcoin, click here.
When to report cryptocurrency (such as bitcoin trades) to the IRS, and how
In 2019, the IRS sent letters to more than 10,000 taxpayers with crypto transactions who may have failed to report income and pay taxes owed. So, now you’re likely wondering when cryptocurrency will begin to affect your taxes. Keep this scenario in mind:
If you owned, say, bitcoin, but engaged in no related transactions last year (i.e., you just held it), you had no taxable event. Nevertheless, you would answer yes to the tax-form question.
Here’s another scenario to consider:
Assuming you aren’t getting paid crypto for work you do (more on that further below), the IRS generally views bitcoin and its brethren as property, not currency, for tax purposes. This means that whether you sell any crypto for cash, trade it for another digital currency or use at a merchant that accepts it as payment, the difference between what you initially bought it for — your cost basis — and its value upon sale is either a gain (profit) or a loss.
So, if you have a gain from crypto, you’ll be taxed on it. As with other other investments like stocks, if you held cryptocurrency for one year or less, any profit you made is considered a short-term gain and is taxed as ordinary income.
If you received any virtual currency as pay for work performed, you are expected to report that, as well, because the crypto is treated like wages in this scenario.
Read more details about when to report cryptocurrency to the IRS here.
So, how do I report cryptocurrency information to the IRS
While cryptocurrency can be super, super easy or insanely complicated, the IRS wants a yes or no answer to the question posed on page 1 of the tax form: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
Remember, “yes” doesn’t necessarily mean more taxes. And finding the necessry tax records to report the most accurate information could be difficiult.
While firms will automatically generate the necessary tax paperwork, that’s not necessarily the case in cryptocurrency exchanges.
While the task of tallying up gains and losses can fall on the cryptocurrency holder, the best piece of advice to taxpayers is to:
- Keep track of your records via tax software or a simple spreadsheet
- Gather up transaction information from wallets and the exchanges (this could be time-consuming, but it’s part of the process, at least until a more effective method hits the market).
- Make an appointment with a tax preparer to give you answers to the questions you might not even know to ask.
Read more about reporting cryptocurrency to the IRS here.
Don’t risk getting into trouble with IRS. Taxes could sound intimidation (and we understand why). But what’s more intimidating is when the IRS starts to go after you because of questionable reports on your tax documents.
Forbes recently published an article that talks about the proper tax forms that will be needed when filing your 2020 crypto taxes. Read it here.