Crypto Taxation

Crypto taxation refers to taxable events in which the governments of respective countries impose taxes on transactions involving cryptocurrency. These taxes apply to individuals, investors, and businesses that earn income from crypto transactions. The tax rates on these transactions can change periodically, such as every year.

Different countries have various crypto taxation rules according to their jurisdictions. In many cases, the tax treatment depends on the legitimacy and regulatory framework surrounding cryptocurrency. In the United States, the Internal Revenue Service (IRS) has specific guidelines for crypto taxation, which apply to various situations and taxable events. However, certain non-taxable events do not trigger taxes on crypto transactions.

Crypto taxation means that individuals and businesses must pay taxes on the crypto tokens they earn. To regulate and potentially benefit from digital assets, governments impose taxes on cryptocurrencies as a source of income. Digital assets refer to crypto coins, stable coins, NFTs (non-fungible tokens), and other convertible tokens. When crypto users earn these tokens, a specific tax percentage (rate) applies to them. However, these rates differ for crypto taxation by country and region.

According to IRS crypto taxation rules in the United States, cryptocurrencies attract taxes in certain taxable events. These events include:

1. Selling crypto coins for cash.
2. Converting one crypto token to another.
3. Using cryptocurrency as a mode of payment for services.
4. Receiving crypto tokens as income or payment from another party.
5. Earning them through mining or staking rewards for block verification performed.
6. Receiving tokens from a hard fork while holding them on the network.
7. Receiving airdrops (in the form of crypto coins) via a marketing campaign.

However, it only applies when the assets are sold or traded. Otherwise, it depends on the holding period and the nature of the transaction. If users buy and hold them for less than a year, they incur short-term capital gains tax rates of 10% to 37%. Assets held for more than a year attract long-term capital gains tax rates of 15% to 20%.

Once a person is eligible for crypto taxation, they must fill out the following forms:

• Form 1040 (for reporting received income in cryptos)
• Form 8949 (for reporting capital gains or losses)
• Form 1099 (for reporting crypto transactions conducted on an exchange)
• Form 1099-NEC (if an independent contractor receives payment in crypto tokens)
• Form W-2 (for receiving wages in cryptocurrency through an employer)

Every country has a different jurisdiction that decides on crypto taxation rules. It depends on the legal status they provide. However, we will look at the steps on how to file crypto taxation in the US:

• Gather All Crypto Transaction Data And Trades - The foremost step in crypto tax filing is considering taxable events. In short, a person must check all crypto transactions and determine whether they are eligible for crypto taxation. If they are taxable, it is feasible to segregate them according to their form category. 
• Calculate The Capital Gains Or Losses - After considering the selective crypto transactions, the next step is calculating the capital gains or losses. Likewise, the capital gains tax will be applicable. If a person bought a Bitcoin at $50,000 and sold it within three months at $60000, he gained $10000. As a result, this capital gain will attract a 10% to 37% tax. However, the percentage depends on the type of individual and amount. 

The schedule for the recent tax rates for long-term and short-term gains in 2023 follows. 

#1 - Short-Term Gains Tax

#2 - Long-Term Gains Tax

• Select The Form - Taxpayers must file Form 1040 and Form 8949 to report any income received in cryptocurrency. They can also file other forms, like Form 1099 and Form W-2. This requirement became necessary after the Infrastructure Investment and Jobs Act (IIJA). 
• File And Report The Crypto Transaction - The last step is to fill in the details in the respective forms and send them to the IRS. However, if there is a crypto loss, taxpayers can file Form 8949 and 1040 Schedule D. 

Let us look at the examples of crypto taxation to comprehend the concept better.

Example #1

Suppose Clevin is a trader who trades in cryptocurrency and NFTs on various platforms. In the past year, he traded many assets and booked some profit for himself. However, most of his trades involved purchases, and only three transactions yielded returns. Since these assets were sold within five months, he calculated the short-term capital gains and losses on the crypto transactions. Let us look at them:

1. Sale of NFT art - $2,000 (profit)
2. Sale of Ethereum coins - $10,000 (profit)
3. Received airdrops - $20,000 (profit)

In this case, the total capital gains from the above transactions are $32,000. Since Clevin is single, a short-term capital gain tax applies to these profits. Short-term capital gains are taxed at ordinary income tax rates. Based on the 2023 tax brackets, if Clevin's total income falls within the 12% tax bracket, he would pay 12% on these gains.

However, if Clevin's capital losses exceeded his gains, he could deduct up to $3,000 of those losses against other income. If he were married and filing separately, the maximum deductible amount would be $1,500.

Example #2

According to a news article from August 2023, the U.S. Treasury Department announced a new set of rules for crypto taxation. As part of these rules, Form 1099-DA will be introduced to help taxpayers determine the amount of taxes owed on digital asset transactions.

Additionally, the new rules expand the definition of "brokers" to include both centralized and decentralized digital asset trading platforms, crypto payment processors, and specific online wallets where users store digital assets. These brokers will be subject to the exact information reporting requirements as brokers of other financial instruments, such as stocks and bonds.

The rules also extend the reporting requirements for certain cash transactions over $10,000 to include digital assets.

There are specific challenges associated with crypto taxation by country. Tax authorities often experience difficulties with these transactions due to the anonymity and security layers inherent in blockchain technology. Addresses developed on various security layers prevent tax authorities from easily tracking the owners of these addresses, increasing the risk of tax evasion.

Another issue is that many countries attempt to create taxation rules to increase crypto users' participation in the tax system. However, this is challenging in the context of tokenomics, as coins are often traded on decentralized exchanges (DEXs). DEXs typically do not provide transaction details to third parties, making it difficult for governments to extract necessary data.

Furthermore, experts believe that the current tax system still needs to be fully compatible with cryptocurrencies. As technology advances, security improves, and new crypto assets and protocols are introduced, taxation rules need constant updates to keep pace with these developments.