As the usage of cryptocurrency increases significantly, rewards like referral bonuses, staking rewards, and cashback offers serve as some of the easiest ways to earn for most people. However, earning such bonuses also attracts tax obligations. For instance, you may be asking, Are crypto rewards taxable? Or is reward money taxable? This blog is going to help you understand crypto reward taxation extensively and comprehensively. Questions such as Are referral bonuses taxable? And Do you pay taxes on cash-back rewards? It will be addressed, too.
What Are Crypto Rewards?
Crypto rewards are any income received in cryptocurrency, most frequently associated with staking, mining, referral programs, or cashback on purchases. These rewards are beneficial but then come with certain tax implications.
Taxation of rewards for various operations, such as purchases in order to gain bonuses in the form of crypto or coin-based tokens, is losing its novelty impact, and governments all over the world are beginning to keep track of such transactions. Therefore, taxpayers have no option but to file returns and include all the income earned from crypto rewards in their tax returns.
Are Crypto Rewards Taxable?
The answer is affirmative. In most places, crypto rewards are taxable, regardless of the circumstances. Incomes of this character are classed as earnings and taxation shall apply on their market value at the moment when the earnings were received.
Now, let’s explore a few examples of a few sources of rewards in crypto networks and their relevant taxation issues:
Staking Rewards
Staking refers to the practice of keeping cryptocurrencies to assist a particular blockchain network and, in return, getting rewards. These rewards are treated as income and taxed whenever they are earned.
Referral Bonuses
Numerous cryptocurrency exchanges and platforms provide referral bonuses to users in exchange for bringing new customers. These bonuses fall under the category of taxable income.
If you are asking whether a referral bonus is taxable, the reply is affirmative, as the fair market value of the bonus when it is credited to your account must be paid as income.
Airdrops and Promotions
Airdrops are the free distribution of cryptocurrency to a user’s wallet. However, as nice as it may be to claim them, they are taxed as ordinary income in the year they are declared.
Cashback Rewards
Some credit cards that are crypto-centric offer rewards in the form of cashback cryptocurrency on the purchases made. The taxability of these relies on the jurisdiction that you lie in.
Is Reward Money Taxable?
Yes, in most instances, reward money is taxable. Be it cash back, staking prizes or bonuses, referral, or otherwise, the tax imposition herein is likened to other kinds of income. Here it is explained further:
Referral Bonuses
Bonus Referral Linear in Nature where taxes Apply. For example, when you introduce a friend to a gentlemen’s club or a restaurant and are given $100 in Citibank or even $100 worth of cryptocurrencies worth in value at this time of referral, it is an income that is taxable in the year of receipt of the income.
Cashback Rewards
Taxation on cashback incentives – Do you incur any taxes if you have these amounts? The response is no, provided the payment was rendered in the form of a discount on a price. Something even more complicated arises when the cashback is in crypto, and it is considered earned income. As a rule, the cash incentive is rewarded to attract more clients. See below to find out more about the regulations in your area.
Staking and Yield Rewards
Any prizes resulting from across staking or yield farming, once credited into your account, are considered income and taxed accordingly. Limitless free trial version.
How to Calculate Taxable Income from Crypto Rewards
In order to calculate your tax liability on income derived from crypto rewards:
Assess Fair Market Value
Determine the value of the cryptocurrency in question at the time one receives it. For instance, consider one earns 0.01 BTC as the reward when the Bitcoin price is at $30,000, the taxable income will equal $300.
Convert to Local Currency
In order to ensure that the annual returns are filed properly, convert the cryptocurrency’s worth to your country’s currency.
Maintain Accurate Records
- The category of compensation (e.g., staking, referral, cashback, etc).
- The time stamp on which the reward was dated.
- The price was fair to all at the time that the item was received.
Do You Pay Taxes on Cash Back Rewards?
The approach to cashback rewards in cryptocurrency may vary from that of conventional cashback programs.
Traditional Cashback
In many jurisdictions, customary cash-back incentives are deemed a purchase discount and are hence exempt from taxation.
Crypto Cashback
Unlike other applications, crypto cash-back may imply an increase in income. For instance, if one is given a one percent crypto cash back for every transaction, then the value of that cryptocurrency when one receives it is also earned and thus taxable.
As such, it is advised that a tax lawyer is consulted to comprehend the legal disposition of such incentives within the concerned locality.
Reporting Crypto Rewards on Your Taxes
To comply with tax regulations:
- Maintain Records of All Rewards
- Keep a systematic account of all the cryptocurrency rewards you earn, including when and how much in value.
- Make Sure to Add them On Tax Returns
- Report them where applicable on tax forms as either included in the gross income heading or as other income.
- Pay Capital Gains Taxes, If Necessary
- If there is any sale or trade of the cryptocurrency received as a reward, capital gains tax will also be applicable depending on the difference between the proceeds and the independent market rate of the said currency at the time of receipt.
Penalties for Non-Compliance
Revenue authorities are known to impose strict penalties, including fines and the accrual of interest on amounts due for not reporting taxable crypto rewards. This is becoming increasingly difficult since governments are using blockchain-based transaction records in order to analyze their taxpayers’ activities.
How to Minimize Your Tax Burden
The following are some solutions to mitigate taxation on crypto rewards:
Hold for the Long Term
In case the laws in your area allow for decreased long-term capital gains tax rates, you may want to think of keeping the cryptocurrency that you have been previously rewarded for more than one year before selling.
Use Tax-Advantaged Accounts
A few nations permit the inclusion of cryptocurrency investments within tax-free structures, allowing investors to pay less taxes overall.
Consult a Tax Professional
A specialist in taxation can advise you depending on your earnings and the laws present in your place of residence.
How Is Staking Taxes Beneficial? The Crypto Rewards
The IRS has made it abundantly clear that cryptocurrency transactions are subject to taxation. Notice 2014-21 states that cryptocurrencies are property and subject to income and capital gains taxes. Like stocks, any dividends or interest are taxed as ordinary income, while any increase in value is a short- or long-term capital gain.
Many DeFi platforms use rewards to incentivize users. For example, suppose that you stake $10,000 of USDC to AAVE and receive $10,000 in aUSDC in return. If AAVE offers a 2.95% interest rate, you will receive $295 worth of aUSDC as an interest payment. You could then sell or exchange the aUSDC or continue to hold it over time.
From an investment standpoint, these dynamics are similar to conventional lending whereby a lender will loan an asset to a borrower in exchange for interest payments and the eventual return of the principal. The difference is that the blockchain enables these transactions to occur peer-to-peer and without the use of a financial intermediary.
Similar to interest income, there are usually taxes on DeFi at ordinary income rates. So in the example above, you would owe regular income tax on the $295 worth of income when you receive it. If aUSDC declined in value, you would still owe income tax on the $295. If you sold aUSDC for USD, you would owe capital gains taxes on any increase in value.
DeFi Tax Nuances & Exceptions
DeFi platforms are constantly evolving, which could impact taxes on DeFi transactions. For instance, suppose that you lend 10,000 DAI to COMP and receive $10,000 worth of cDAI in return. If COMP offers a 2.95% interest rate, the value of your cDAI will increase by $295. You would then owe capital gains tax after selling or exchanging the cDAI.
The minting of interest-bearing tokens is another grey area of the law. Suppose you mint aTokens or cTokens or transfer into or out of liquidity pools. In that case, you may realize capital gains on the underlying assets minted into tokens since they’re crypto-to-crypto trades. On the other hand, some tax experts consider these non-taxable migrations.
Another common scenario is receiving a DeFi reward that falls in value. In that case, you would owe income tax on the original amount—establishing a new cost basis—and potentially write-off the decrease in value from the cost basis. The IRS lets you offset all of your capital gains across different asset classes along with up to $3,000 of ordinary income.
It’s important to remember that the DeFi tax law is fluid and constantly changing. Since the IRS hasn’t given much definitive guidance, investors should work with tax professionals to ensure that their interpretation is defensible. It’s also a good idea to keep an eye out for any additional tax guidance or clarifications from regulatory authorities.
Tracking DeFi Tax Obligations
A common challenge for DeFi investors is tracking their liabilities arising from rewards for crypto staking taxes. While looking up past cryptocurrency transactions is pretty straightforward, tracking past reward tokens is far more complex. As a result, investors must keep diligent records to ensure that they comply with IRS taxes—particularly for audit defense.
One way to simplify tax reporting is to use a single platform. For instance, Coinbase Wallet enables users to lend their crypto and earn interest on DeFi protocols. Since everything is in one wallet, it’s much easier to access a transaction record and ensure that you have all the data you need to complete your taxes each year.
ZenLedger makes it easy to connect your wallets and exchanges to track DeFi transactions automatically. That way, you don’t have to worry about keeping separate records or paying accountants to go through a mountain of paperwork. Instead, you can click a button and prepopulate the tax forms you need each year or even integrate with TurboTax. Try it for free!
How To Report Staking Rewards On Taxes?
Most DeFi transactions fall under hobby or business income. In most cases, business income is subject to higher tax rates since you must pay Social Security and Medicare taxes on top of conventional income taxes on crypto rewards. While it’s tempting to classify everything as hobby income, the IRS is very diligent in ensuring that you’re paying the appropriate taxes.
There are some important differences between the two classifications:
- Business Income: The IRS considers you a business if you invest a substantial amount of time with the goal to boost profits and depend on the income for your livelihood. Business income is typically reported under Form 1040 Section C and may trigger self-employment taxes, although you can deduct your expenses.
- Hobby Income: The IRS considers hobby income to be income that arises from small investments and modest earnings. If that’s the case, you will typically file taxes under the “Additional Income” section of Form 1040. If you earn more than $400 per year, you may need to file income under Schedule SE and pay additional taxes.
Investors that report business income can deduct certain expenses. For example, they may be able to deduct educational expenses or subscriptions, the cost of dedicated computer equipment, and even things like office space as long as it’s not used for anything else. Talk with your accountant to maximize deductions in a way that minimizes audit risks.
When is Staking Rewards Income Recognized?
The income from staking is recognized at the ‘time of receipt.’ In certain situations, however, the time of receipt can be unclear. For instance, a few investors earning their rewards via a third party are not sure if they should realize their income when they earn the reward or when they withdraw the reward into their wallet.
For a better understanding of taxable staking rewards, understanding the idea of ‘dominion and control’ is crucial. According to tax experts, when investors receive staking rewards, they have dominos and control over their tokens. Therefore, the IRS believes that the investors can withdraw their rewards and they are constructively received. As a result, the staking rewards are recognized at the time of receipt.
How is Crypto Rewards Taxed in a Staking Pool?
Earnings from staking pools are considered income when you receive them. Even if you don’t withdraw your reward, the coins are under your dominion and control and you have the ability to withdraw them.
However, if you deposit or withdraw your rewards from a string pool, it is not seen as a taxable event similar to a wallet-to-wallet transfer.
What if I Can’t Find Out the Fair Market Value of My Rewards?
Oftentimes, it gets challenging to find out the fair market value of the staking rewards when you receive them. At a time like this, you can consult a certified tax professional and determine a method to calculate your staking income.
The Bottom Line
Decentralized finance has become tremendously popular, with more than $90 billion locked up over the past few years. However, investors that use these protocols to earn interest should keep taxes on crypto rewards in mind. Fortunately, ZenLedger and other crypto tax software make it easy to automate the process and create the paper trail you need.
ZenLedger easily calculates your crypto 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!
