Many people holding bitcoin have seen massive gains, some becoming overnight millionaires. Some employees are paid with Bitcoin, more than a few retailers accept Bitcoin as payment, and others hold the e-currency as a capital asset. And anybody involved in such transactions should pay tax on cryptocurrency. Since bitcoin and other cryptocurrencies are seen as property by the U.S. government (and not only the US), capital-gains taxes apply to every transaction made. Even if you were just buying a cup of coffee in bitcoin you would have to report every sale of bitcoin. How to pay taxes on Bitcoin? Well, paying taxes on bitcoin might be a complex issue.
Do you Have to Pay Taxes on Bitcoin?
Bitcoin is now listed on exchanges and has been paired with leading world currencies such as the US dollar and the euro. The US Federal Reserve acknowledged the growing importance of bitcoin when it announced that bitcoin-related transactions and investments cannot be deemed illegal. At the start bitcoin’s attractiveness was attributed partly to the fact that it wasn’t regulated and could be used in transactions to avoid tax obligations. The virtual nature of bitcoin and its universality also make it harder to keep track of in cross-country transactions. In addition, government authorities around the world soon realized that bitcoin attracted black marketers who could make illegal deals. Naturally, it was impossible for bitcoin to escape the tax authorities’ radars for long.
Bitcoin is the most widely circulated digital currency or e-currency as of 2017. It’s called a convertible virtual currency because it has an equivalent value in real currency. The sale or exchange of a convertible virtual currency—including its use to pay for goods or services—has tax implications.
Tax authorities around the world have tried to bring forth regulations on bitcoins. The US Internal Revenue Service (IRS) and its counterparts from other countries are mostly on the same page when it comes to treatment of bitcoins. The IRS said that the bitcoin should be treated as an asset or an intangible property and not a currency, as it is not issued by central bank of a country. Bitcoin’s treatment as an asset makes the tax implication clear.
Common tax terminology
- Capital asset might be anything you own: house, car, stocks or cryptocurrency like bitcoin;
- Basis is the amount you paid to buy bitcoin (including the fees);
- Realized capital gain or loss – the profit or loss you made when you sold bitcoin. Losses can be deducted from your taxes;
- Unrealized gain or loss – the profit or loss you have on paper, but you have not actually cashed in on. You do not pay taxes on unrealized gains;
- Short-term gain is a realized gain on bitcoin or other investment that lasted for a year or less before you sold it;
- Long-term gain is a realized gain on bitcoin or other investment that lasted for more than one year before you sold it.
An employer paying his/her employees with Bitcoin must report employee earnings to the IRS on W-2 forms.
- You must convert the Bitcoin value to U.S. dollars as of the date each payment is made and keep careful records.
- Wages paid in virtual currency are subject to withholding to the same extent as dollar wages.
Employees must report their total W-2 wages in dollars, even if earned as Bitcoin. Self-employed individuals with Bitcoin gains or losses from sales transactions also must convert the virtual currency to dollars as of the day received, and report the figures on their tax returns.
Bitcoins as capital assets
If you hold Bitcoins as a capital asset, you must treat them as property for tax purposes. General tax principles applicable to property transactions apply. Like stocks or bonds, any gain or loss from the sale or exchange of the asset is taxed as a capital gain or loss. Otherwise, the investor realizes ordinary gain or loss on an exchange.
Bitcoin for miners
According to the IRS, when a taxpayer successfully “mines” Bitcoin and has earnings from that activity whether in the form of Bitcoin or any other form, he or she must include it in his gross income after determining the fair market dollar value of the virtual currency as of the day you received it. If a bitcoin miner is self-employed, his or her gross earnings minus allowable tax deductions are also subject to the self-employment tax.
How to Pay Taxes on Bitcoin?
How to Pay Taxes in the UK?
If you are a resident of Great Britain who buys and sells a bitcoin token and it appreciates or depreciates in value between buying and selling, the gain is taxable and the loss should be afforded tax relief. And the HMRC even published a broad guide to cryptocurrency taxation in 2014.
You also have to pay taxes when trading one digital coin for another. Let’s say, you had bought Bitcoin using GBP and then uses your bitcoin to buy another coin, e.g. Ethereum, next week. If that is more than the sterling cost of the bitcoin, it’s subject to Capital Gains Tax at 10 or 20 percent depending on your other income.
You are probably aware that every UK resident has a Capital Gains allowance of £11,300 per year, so if your total gains for the year are less than that, it’s tax free.
If you are a bitcoin investor with a huge volume of transactions, a high level of organization, large amounts of time spent buying and selling coins, then you can also be taxed through higher rates of income tax.
How to Pay Taxes in the US?
The IRS has made it mandatory to report bitcoin transactions of all kinds, no matter how small in value. Thus, every US taxpayer is required to keep a record of all buying, selling of, investing in, or using bitcoins to pay for goods or services. Because bitcoins are being treated as assets, if you use bitcoins for simple transactions such as buying groceries at a supermarket you will incur a capital gains tax (either long-term or short-term depending on how long you have been holding the bitcoins).
Your bitcoin holdings aren’t taxable (at least not yet), but any time you sold bitcoin or used it to buy something, you were accruing taxable income.
How is cryptocurrency taxed in USA? When it comes to bitcoins, the following transactions will lead to taxes:
- Selling bitcoins, mined personally, to a third party.
- Selling bitcoins, bought from someone, to a third party.
- Using bitcoins, which one may have mined, to buy goods or services.
- Using bitcoins, bought from someone, to buy goods or services.
Scenario 1 and scenario 3 entail mining bitcoins, using personal resources, and selling them to someone for cash or equivalent value in goods and services. The value received from giving up the bitcoins is taxed as personal or business income after deducting any expenses incurred in the process of mining. Such expenses may include the cost of electricity and computer hardware used in the mining of bitcoins. Thus, if one is able to mine 10 bitcoins and sell them for $250 each. You have to report the $2500 as taxable income before any deductible expenses.
Scenario 2 and scenario 4 are more like investments in an asset. If you bought BTC for $200 each, and one bitcoin was given up in exchange of $300 or equivalent value in goods. The investor has gained $100 on one bitcoin over the holding period and will attract capital gains tax (long-term if held for more than one year, otherwise short-term) on $100 earned by selling/exchanging the bitcoin.
If bitcoins are held for a period of less than a year before selling or exchanging, a short-term capital gains tax is applied, which is equal to the ordinary income tax rate for the individual. However, if the bitcoins were held for more than a year, long-term capital gains tax rates are applied. In the US, long-term capital gains tax rates are:
- 0% for people in 10%-15% ordinary income tax rate bracket,
- 15% for people in the 25%-35% tax bracket,
- 20% for those in the 39.6% tax bracket.
Thus, individuals pay taxes at a rate lower than the ordinary income tax rate if they have held the bitcoins for more than a year. However, this also limits the tax deductions on long-term capital losses one can claim. Capital losses are limited to total capital gains made in the year plus up to $3000 of ordinary income.
How to file your income taxes on bitcoin?
You need to document everything, so it will be easier for you to fill in your tax form. You’ve already got records of most of your bitcoin transactions, either on the blockchain or from your wallet provider, but converting it to dollars can be a real hassle since you’ll need to run the bitcoin value against the price of bitcoin at the time of the transaction.
There is also software that can help with doing bitcoin taxes, such as Bitcoin.Tax and CoinTracking.Info. Bitcoin.Tax lets you upload CSV files from exchanges, and it’s free for up to 100 transactions. CoinTracking.Info does the same, and it’s free for up to 200 transactions.
Any income from the bitcoin sales needs to be reported on Schedule D, an attachment to Form 1040. Depending on how long ago you bought your bitcoin, it will be taxed either as a short-term or a long-term capital gain.
The tax rate on your bitcoin sales depends on how you got your bitcoin and how long you’ve held it:
Bitcoin gained through mining is taxed as ordinary income, based on the “fair market value” of the bitcoin at the date it was received. If the mining counts as a trade or business transaction, and the taxpayer isn’t doing it for an employer but for themselves, they have to pay the self-employment tax, which is 15.3 percent on the first $127,200 of net income and 2.9 percent on any income in excess of $128,400.
Bitcoin received as payment for goods or services. In this case it is taxed as ordinary income. Depending on your income bracket for the last year, the federal tax rate can be anywhere from 10 percent to 39.6 percent. The bitcoin will also be subject to state income tax.
Foreign bitcoin account. This is where you have to report the value of the account to the US Treasury using FinCen form 114, and to the IRS with the form 8938. US residents and citizens who own less than $10,000 of assets abroad don’t have to report.
How to Pay Taxes in Canada?
Bitcoin is popular for online payments and transfers due to its built-in encryption and security methods, as a result, it has captured the attention of many non-traditionalists and tech-minded people. Is cryptocurrency taxable in Canada as well? Yes, it has also captured the attention of the Canada Revenue Agency, who has altered existing tax codes to help address profits and transactions associated with virtual currencies.
The tax code considers transactions with bitcoins or other virtual currency as barter and trade transactions. It means that Canadians must declare any income received or expenses made, regardless of whether any actual cash was tied to the transaction.
For example, if you run a business and receive bitcoins in exchange for your services, you are still required to report these transactions on your income taxes. Since you can’t declare bitcoins on your tax form, you must declare the typical dollar amount that you would have otherwise claimed for those services.
If you usually charge $200 per week for your services, you must declare $200 as income on your return — even if you accepted different types of payment. Similarly, the person who provided you with the trade may declare the $200 as an expense on their income tax return.
To assign dollar amounts for these transactions, you must use the exchange rate between the virtual currency and the Canadian dollar on the day of the transaction.
For example, if you purchased inventory for your shop with Bitcoin and the cost was three bitcoins, you need to find the exchange rate for the day the purchase was made. If the exchange rate was $316 for one Bitcoin, your deduction for that inventory purchase would be $948.
Similarly, if you paid an employee using Bitcoin, you would have to convert the payment to Canadian dollars using the exchange rate from the day the payment was made. Your employee would have to use the exchange rate to determine how much income to declare.
If you buy, hold and sell virtual currency, and make a profit in the process, you must claim that profit as a capital gain. The portion of the Canada Revenue Agency’s tax code regarding securities exchanges applies to these transactions.
What happens if you don’t pay taxes?
If you sold crypto-coins or used crypto to buy anything in 2017, you probably owe taxes to your country. And not paying up can have consequences. If e.g. IRS discovers you under-reported your income when you file your taxes in April, there is a failure-to-pay penalty of 0.5 percent per month, starting after the month in which it was due. Then there is a failure-to-pay penalty of 5 percent on top of that.
Be sure that crypto is on the IRS’s radar. The IRS has gone after bitcoin tax evaders before. In 2016, the IRS requested the Coinbase records of all the people who bought bitcoin from 2013 to 2015. After examining tax returns from those years, the IRS found that only around 800 people reported their bitcoin gains on the form 8949 each year.
Even if you aren’t a hefty Coinbase user, you’re obligated to report, and every U.S. taxpayer can potentially be audited by the IRS. The IRS examined 0.6 percent of the 193 million tax returns filed in fiscal year 2016, or about 1.2 million.
If the IRS catches on that you didn’t pay the tax, you’ll be dealt with like any other tax evader. You’ll be sent a deficiency notice which you can either pay or contest. And the IRS could always later catch you in a regular audit. If the IRS thinks you knew about the bitcoin tax rates and laws and faked your tax return anyway, it will charge you an additional 75 percent of the underpayment for fraud.
How to Minimize Bitcoin Taxes?
One of the possible ways to reduce your bitcoin taxes is to donate cryptocurrency to charities. But you must donate directly to the charity, as selling it first would be taxable. The Water Project, Wikileaks, and the Internet Archive would be glad to receive your bitcoin donation. Robert Wood, a tax lawyer, says, donating bitcoin to charity “can be a smart move, generating a tax deduction for the market value, without having to pay tax on the appreciation.”
Taxation on bitcoins and its reporting is not as simple as may seem. It is rather difficult to determine the fair value of the bitcoin on purchase and sale transactions due to its volatility and there are huge swings in prices in a single trading day. However, make sure you are a law-obedient citizen who pays the taxes. For your own sake.