Bitcoin and other convertible virtual currencies have gained a lot of traction over the last several years. In its infancy, there was a lot of grey area in terms of how the IRS viewed cryptocurrency. This lack of guidance led to tax discrepancies for some crypto traders, and now the IRS is beginning to ratchet up enforcement. Last year, the IRS began a major crackdown on crypto tax evasion, so bitcoin traders should take notice. Here is what you need to know about bitcoin taxes to stay compliant in this new era of IRS enforcement.
Taxable Bitcoin Transactions
The IRS views bitcoin and other convertible virtual currencies as property, not currency. This determines how bitcoin is taxed. Trading bitcoin creates a taxable event that results in either a capital gain or loss. Some notable examples of taxable events include:
- Trading cryptocurrency for fiat currency
- Trade virtual currency for other virtual currency
- Crypto mining
- Units received as the result of a hard fork
- Units received as compensation for goods or services
Capital gains are taxable income, but tax rates vary based on how long you held the asset before trading. A capital loss can be taken as a tax deduction. Simply buying cryptocurrency does not create a taxable event, as gains are not realized until the sale of the unit. Receiving bitcoin as a gift also does not create a taxable event, unless it exceeds the gift tax exemption amount. In addition, if you are holding onto the asset with the anticipation of a gain or loss, a taxable event is only created upon the sale or trading of the asset.
Bitcoin Tax Rates
The rates that your bitcoin taxes are calculated at will depend on several things:
- How long you owned the bitcoin
- Your capital gains tax rate
If the bitcoin is held for less than a year before it is sold or traded it will be subject to the short-term capital gains rate, which is based off of your ordinary income tax rate. However, if you held the bitcoin for a year or longer, it will be subject to the long-term capital gains tax rate. The long-term capital gains tax rate is either: 0%, 15%, or 20% and is based on your taxable income and filing status.
How to Calculate Your Bitcoin Tax Bill
To calculate your bitcoin taxes, you will need to know the fair market value of your bitcoin and you will need to calculate your capital gains. Capital gains are calculated by finding the difference between the price with which you acquired the asset (base cost) and then sold it. Your base cost should also include any transfer fees or costs associated with buying your bitcoin. If you earn a profit, you have a capital gain and will need to file a schedule D. If you come out on the other side with a loss, you can write off up to $3,000.
As we mentioned above, how you are taxed depends on the length of time you owned the asset. If you bought bitcoin and then sold it within a year, it will be subject to the short-term capital gains rate, which is higher than the long-term capital gains rate because it is based on the individuals personal income tax rate. The long-term capital gains rate for the 2019 tax year is as follows:
- 0% for single filers who earn between $0 – $39,375
- 0% for joint filers who earn between $0 – $78,750
- 15% for single filers who earn between $39,376 – $434,550
- 15% for joint filers who earn between $78,751 – $488,850
- 20% for single filers who earn $434,551+
- 20% for joint filers who earn $488,851+
Because of this, if you have been buying and trading bitcoin for several years, it makes more sense to depose the cryptocurrency you have held longer, so as to reduce your tax liabilities.
Paying Bitcoin Taxes
If you earned a profit from selling or trading bitcoin, you will need to pay taxes on your gains. Again, a taxable event is only created upon the sale or trade of an asset. To pay your bitcoin tax bill, the easiest way to pay is online. You can create an account online on the IRS website. From there you can pay with a direct debit from your checking account, pay by debit card, or pay by credit card. You can also set up an installment plan, if you are unable to pay the entire amount. Just be sure to set up your installment plan before the income tax deadline to avoid unnecessary penalties.
IRS Penalties for Undeclared Bitcoin
Skipping out on your bitcoin earnings is considered tax evasion by the IRS. Over the last several years, the IRS has taken grave steps to minimize any uncertainty about how capital gains from bitcoin is to be treated. While declaring your bitcoin earnings may be a simple mistake on your part, the IRS is taking it very seriously. Failure to pay your bitcoin taxes will result in a deficiency notice from the IRS. For which you can either pay or contest. Failure to pay your bitcoin taxes could also result in an audit, this can result in an understatement penalty of 20%. If the IRS finds that you intentionally underreported, you could face a penalty of 75% of the underpayment.
Bitcoin Compliance Help
Professional tax advisors can help you stay compliant with IRS crypto regulations. Plus, they can show you tax planning strategies that will minimize your bitcoin taxes. Don’t let a simple mistake land you in hot water with the IRS. Click here to sign up for a free one-on-one strategy session with a Shared Economy Tax pro now. We’re here to answer all of your most pressing tax questions. Also, don’t forget to sign up for our free newsletter using the form below to get free tax tips in your inbox.