Bitcoin Taxes

Bitcoin Taxes: The Ultimate Guide To Bitcoin And Taxes

October 29, 2021
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    Bitcoin prices have been a rollercoaster ride over the past several years. Some investors have realized significant windfalls and others have experienced losses. In either case, it’s important to properly account for your bitcoin taxes to ensure that you remain on the right side of the law and potentially realize tax deductions.

    In this article, we will take a look at how the IRS treats Bitcoin and other cryptocurrencies and how to include Bitcoin tax gains and losses in your tax return to avoid any problems!

    How Is Bitcoin Taxed In The United States?

    Bitcoin was originally designed to be a digital representation of value that functions like a “real” currency (e.g., the coin and paper form of money). In the original white paper, Satoshi Nakamoto designed the cryptocurrency to avoid the need to trust third-party financial institutions to process payments, reduce transaction costs, and pave the way for microtransactions.

    But even with these goals, the IRS treats bitcoin as taxable property like stocks or real estate, and you must report capital gains or losses and pay the appropriate bitcoin tax rates. These tax rates depend on how long the position was open and your individual tax bracket during a given year.

    Understanding Bitcoin And Taxes

    The IRS has made it clear that Bitcoin does not have legal tender status in any jurisdiction and must be treated as property for federal tax purposes. Property gains are subject to federal ordinary income or capital gains taxes, unlike foreign currency gains or losses. This includes Bitcoin purchased for investment, received as compensation, or mined by computers.

    Do All Bitcoin Holders Have To Pay Bitcoin Taxes In The US?

    Bitcoin owners are regulated to pay federal income tax on Bitcoin, i.e., any capital gains realized upon the exchange of Bitcoin for U.S. dollars, euros, virtual currencies, or other assets. In practice, this means that you must compute the fair market value and cost basis to determine the gain or loss on the transaction. The cost basis is especially important to track because you may owe tax on the entire proceeds without any accurate cost basis. 

    Read more about this with our The 2021 Guide to Bitcoin Taxes.

    How Is Bitcoin Taxed: Are All Bitcoin Transactions Taxable?

    The Internal Revenue Service (IRS) states that the following Bitcoin transactions would have tax implications:

    • Selling Bitcoin that you have bought from someone or mined yourself to a third party

    For example, you mined some Bitcoin worth $2,000 and sold it at $3,500. So you will have a capital gain of $1,500 and this gain will be subjected to long or short-term capital gains tax, depending on the holding time of the asset.

    The tax implications remain the same even if the Bitcoin was purchased from a cryptocurrency exchange or received from another person.

    • Using Bitcoin that you have bought from someone or mined yourself to buy goods and services

    For example, if you buy pizza with Bitcoin mined at home, you must pay taxes on the transaction. The amount of taxes levied is determined by the transaction's characteristics, such as the value of Bitcoin at the moment of sale and the price of the pizza.

    Bitcoin Taxes: Capital Gains Tax Or Ordinary Income Tax?

    If you do fall in the category of Bitcoin holders that must pay a tax, you must first determine whether to pay capital gains or ordinary income tax on Bitcoin. Here's a brief breakdown of the two. 

    • Ordinary Income: Ordinary income taxes apply when Bitcoin is not a capital asset. For example, a retailer that accepts Bitcoin or a consultant paid in Bitcoin would report any gains as ordinary income.
    • Capital Gains: Capital gains taxes apply when the Bitcoin is held as a capital asset, like a stock or bond. For example, an investor that believes Bitcoin prices will rise might have purchased Bitcoin a few years ago and sold it at a profit.

    Here are the events that’ll trigger income taxes:

    • Acquiring cryptocurrency using an airdrop
    • Any cryptocurrency interest revenues from lending through decentralized finance (DeFi)
    • Cryptocurrency obtained through liquidity pools and staking
    • Earnings from cryptocurrency mining include block rewards and transaction fees.
    • Receiving cryptocurrency as a reward for performing tasks, such as bug bounties

    It must be noted that the capital gains tax rates are often lower than ordinary income tax rates, so it’s important to determine the correct tax treatment to avoid overpaying taxes. Individual tax rates vary widely depending on a person’s income, dependents, tax credits, tax deductions, and other factors.

    The IRS also outlines a few edge cases that apply to Bitcoin Miners and Bitcoin Compensation:

    • Bitcoin Miners: Bitcoin miners must include the fair market value of the cryptocurrency at the date of receipt in their gross income. In addition, they must pay self-employment taxes as any small business would, although they can also deduct any expenses associated with mining on their tax return.
    • Bitcoin Compensation: Consultants that accept Bitcoin must include the fair market value of the cryptocurrency on the date received for services performed as an independent contractor. Bitcoin paid by an employer for remuneration for services also constitutes wages for employment tax purposes.

    How To Report Bitcoin On Taxes?

    The process of preparing taxes can be very challenging even before including Bitcoin gains and losses, but fortunately, it is starting to get easier. Cryptocurrency exchanges are making it easier than ever to comply with these laws. Coinbase and other major exchanges provide 1099-MISC forms to individuals with large enough gains and provide everyone with easy access to their transaction history. This is especially helpful for crypto-to-crypto transactions.

    ZenLedger crypto tax software makes it easy for you by aggregating data from numerous exchanges, calculating your taxes, and generating common IRS forms like Form 8949 and Schedule D during tax season. If you experienced Bitcoin losses, you can even automate the process of harvesting those losses to offset other gains. These capabilities reduce the amount of time that your CPA requires to file your taxes—potentially lowering your costs.

    Read more about the benefits of a Bitcoin Tax Calculator.

    Tips For Reporting Taxes And Preparing For The Tax Season

    1. Keep a record of all your crypto transactions

    You'll need records of your bitcoin's fair market value when you mined or bought it as well as its fair market value when you used or sold it. You’ll also need to record the date of the transactions. This information will assist you in calculating your bitcoin taxes.

    2. Sort out your tax documents

    Spend some time organizing your tax documents and financial records to make the filing process faster and easier. To determine your previous income, deductions, and credits, use your prior year's tax return as a starting point.

    3. Decide if you want to hire a crypto certified public accountant (CPA) or do it yourself

    A CPA is a trusted financial counselor who assists corporations, people, and other organizations in planning and achieving their financial objectives. A crypto CPA can assist you with tax preparation and more.

    Increased IRS Enforcement on Bitcoin Taxes & What It Means for You

    ZenLedger’s Chief Operating Officer, Dan Hannum, gave an interview to The Wall Street Journal about the IRS gearing up to deploy a change to the 2020 tax form that directly affects crypto investors. By now, it is no secret that the IRS has a plan for increased enforcement on crypto.

    For context, 2019 was the first time the IRS asked if an individual had participated in buying, selling, or holding digital assets by putting the question on the Schedule 1 form — not necessarily requiring an answer. But fast-forward just 1 year later, and the IRS has chosen to highlight the question on the first page and place it above the fold on the Standard 1040 tax form. In changing the positioning of the question, the IRS is now requiring an answer to this question.

    • “At any time during 2020, did you sell, receive, send, exchange, or otherwise acquire any financial interest in any virtual currency?” You must either check “Yes” or “No”

    Have You Received An IRS CP2000 Letter? Here Are Your Next Steps.

    What Does This Mean for the Average Bitcoin Investor?

    In 2020, global users holding crypto assets surpassed 100,000,000 and the IRS has become more serious about compliance. Even if you have multiple exchanges and wallets spread across various platforms, you’ll need to gather all of your transactions and report on them.

    To hear the specific steps you should be taking to ensure you’re accurately reporting crypto transactions on your tax returns, check out our blog about How To File Your DeFi and Cryptocurrency Taxes

    Bitcoin Not Only Turns 13, But Calls For A Celebration With Its New High!

    After undergoing a six-month-long rally, the Bitcoin network attains its new all-time high hash rate of up to 207.53 EH/s.

    Marking its 13th year from when Satoshi Nakamoto, the Bitcoin’s creator mined the genesis block, it had mined a reward from 50 Bitcoin on Jan. 3, 2009, to now reaching a new all-time high hash rate of 207.53 EH/s.

    This has been a remarkable comeback from when the Chinese miners began migrating to friendly jurisdictions. Bitcoin network, with its 207.53 EH/s reclaims the network’s security by increasing the mining difficulty.

    As for a Cointelegraph report, the purchases made by Michael Saylor’s MicroStrategy exceeded about $6 billion in crypto assets, with the firm alone purchasing 1,914 BTC, worth $94 million.

    Bitcoin’s Scenario In The USA as in January, 2022

    As for the data on January 4, 2022:

    • Bitcoin price is $46,478.88 USD with a 24-hour trading volume of $34,616,398,357 USD
    • It has faced a down of 0.82% in the last 24 hours
    • As for the current CoinMarketCap ranking, Bitcoin stands #1 with a live market cap of $879,357,445,589 USD
    • The crypto coin has a circulating supply of 18,919,506 BTC coins with a max. supply of 21,000,000 BTC coins

    The Bottom Line

    Bitcoin prices have experienced considerable volatility over the years, resulting in significant gains and losses for investors. At the same time, the IRS and SEC have stepped up their enforcement actions to ensure that crypto companies are playing by the rules and crypto investors are paying their fair share.

    Thankfully, ZenLedger can help you easily file your bitcoin taxes as we offer integration with all major players and full DeFi support. We can even help you amend previous tax year forms! The best part: ZenLedger has live support available 7 days a week by online chat, email, phone, or by appointment — we want to help you succeed in navigating these waters.

    There is no doubt that there will be an increased IRS enforcement tax on Bitcoin in 2021, but with ZenLedger and our crypto tax calculator, we can help take away the stress and simplify the complicated bits.

     ZenLedger easily calculates your bitcoin taxes and also finds opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!

    Disclaimer: This material has been prepared for informational purposes only and is not intended to provide, tax, legal or financial advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

    Bitcoin Taxes FAQs

    1. How to cash out bitcoins without paying taxes?

    An IRA or your Individual Retirement Account could be one of the simplest ways to avoid paying tax on Bitcoin. While traditional IRAs allow investors to defer tax on Bitcoin gains unless the investor takes up distribution, it gets better if you qualify for a ROTH IRA because then, the money you contribute is tax-free!

    2. Can the IRS track Bitcoins?

    Yes, very much so! A “matching” mechanism embedded in the IRS Information Reporting Program (IRP) informs the IRS that you have reportable cryptocurrency transactions. In other words, if you receive a Form 1099-K or Form 1099-B from a crypto exchange, the IRS knows that you have reportable cryptocurrency transactions.

    3. How is Bitcoin Taxed?

    The Internal Revenue Service treats bitcoin as taxable property. As with stocks or real estate, you must report capital gains or losses and pay the appropriate bitcoin tax rates. These tax rates depend on how long the position was open and your individual tax bracket during a given year.

    4. How to report Bitcoin on taxes?

    Bitcoin transactions should be recorded on Schedule D, which is an addendum to Form 1040. The type of bitcoin revenue—ordinary income or capital gain—should be declared under the appropriate heading in the corresponding columns of the form, depending on the type of trade. Instead of doing it all manually, you can take the help of software like Coinbase and ZenLedger.
    Get Started Now

    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

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