In the last few years, the crypto market has been extremely volatile. One can even say that it is one of the most volatile non-derivative financial assets out there. On one hand, Bitcoin’s value has dropped significantly in the past few months, and also stablecoins have grown steadily in the same time frame.
Stablecoins are the type of cryptocurrency that is pegged or linked to a stable reserve asset such as precious metals or fiat currencies. Stablecoins have become an integral part of the global crypto market because of their ability to maintain plenty of liquidity without having cash reserves. As a matter of fact, Tether (USDT), the most well-regarded stablecoin, conducts around 70 percent of Bitcoin trades. In the past few months, the supply of Tether has catapulted to 78 billion in circulation..
So, if you hold Tether, do you have to pay taxes on it? In this article, we will provide valuable insight on stablecoin taxes and also answer how is stablecoin interest taxed? But, before we begin, let’s properly understand what a stablecoin actually is.
What is a Stablecoin?
Crypto investors who have invested in Bitcoin and Ethereum are hesitant to use them in day-to-day transactions. They believe that if they use these coins they will incur capital gains, and fail to benefit from their future price appreciation as these assets are long-term investments.
To solve this predicament, stablecoins were brought into the picture. Stablecoin investors can use them on a daily basis as their prices are the same as the fiat currency they are pegged to such as the USD.
A stablecoins price remains stable for a long period of time and they were designed to track the cost of currencies or external commodities. Currently, there are stablecoins that track oil, gold, and the South Korean currency, the Won. But, the most popular ones track USD.
With that out of the way, let’s move on to answer the question of whether “do you have to pay taxes on stablecoins or not?”
Are Stablecoins Taxed?
Even though stablecoins were made to be used in day-to-day transactions, they are treated the same as other cryptocurrencies from a taxation point of view.
Buying goods or services with stablecoins or exchanging them with another crypto token is deemed as a taxable event. Based on how the prices of your stablecoin fluctuate, you will incur a capital gain or loss. Since a majority of stablecoins are pegged to the US dollar, it is highly likely that you will incur a capital gain of $0. However, all your crypto transactions should be reported on your tax returns.
Trading Cryptocurrency for Stablecoin
If you trade tokens such as Ether or Bitcoin for a stablecoin it is seen as a disposal event and you have to pay taxes on stablecoins. Your capital gains or losses will be based on the price fluctuations of your coin since you initially receive them.
Receiving Stablecoin as a Payment
Do you have to pay taxes on stablecoins if you received them as payment for goods or services? The answer is a resounding yes. You’d have to report the payment as ordinary income and your taxes will be based on what tax bracket you fall into.
What if You Transfer Stablecoin Between Wallets?
You don’t have to pay stablecoin taxes if you transfer them between wallets as it is not considered a taxable event and you don’t even have to report them on your tax returns.
How is Stablecoin Interest Taxed?
Several crypto exchanges allow users to be interested in their stablecoins. If you receive rewards from your stablecoins in the form of interest, it will be looked at as ordinary income and will be taxed accordingly.
The stablecoin issuance tax implications are dependent on what type of coin is issued. Let’s say you exchange a fiat-backed stablecoin with fiat currency. This should not be considered a taxable event because the transaction is a transition of fiat currency into a digital asset. Even though the transaction is a taxable event, the resulting gain or loss should be zero as the exchange value of the fiat currency and the fiat-backed stablecoin are the same.
Similarly, according to traditional tax principles, if a taxpayer receives a collateral-backed stablecoin, the transaction should not be considered a taxable event. In this exchange, the taxpayer is simply receiving stablecoins by putting digital or physical assets as collateral. As a result, there’s no exchange taking place since the taxpayer will receive his collateral once they redeem the stablecoins.
However, if a taxpayer has an unrealized gain on the crypto token placed as collateral for the received stablecoin, should the gain be recognized on the collateral? The answer is unclear as the IRS guidance on Notice 2014-21 and the traditional tax principles collide.
The aspect that is clear is that taxpayers who receive algo-backed stablecoins via airdrops have to pay stablecoin taxes upon receipt. The difference between the cost basis of the stablecoin at the time of issuance and the fair market value dictates the amount of tax in this case. However, in reality, the taxpayers shouldn’t pay any stablecoin taxes because airdrops occur to promote the stablecoins and have nominal value when issued.
Redemption of Stablecoins
From a federal tax point of view, stablecoin redemption should be seen as the same as the issuance of stablecoins. When the fiat-backed stablecoins are redeemed, a smart contract burns the redeemed coins and moves the fiat currency back to the taxpayer.
As we know that the value of one stablecoin is the same as one unit of fiat currency, the redemption of a stablecoin does not result in any gain or loss. Since taxpayers are receiving their collateral back after the redemption of their collateral-backed coins, there isn’t any gain or loss in theory.
However, what should be the tax implications if the value of the collateralized cryptocurrency sharply declines and creates an under-collateralization of issued stablecoins? In such situations, the exchange will buy back the issued stablecoins by force selling the collateral. And if any collateral remains, it is transferred back to the taxpayer.
Lastly, as algo-backed stablecoins are not backed by fiat currency or other collateral, the coins are irredeemable. You can only exchange them for other property or cryptocurrencies. Also, as we’ve already mentioned, the exchange results in a taxable event.
Stablecoins are some of the safest investment options in the crypto market and Tether (USDT) is at the top of that list. However, if you buy goods or services using stablecoins, you have to pay stablecoin taxes. Similarly, if you exchange stablecoins with other cryptocurrencies or receive them as payment, they will be taxed accordingly. However, you don’t have to pay stablecoin taxes if you transfer them between wallets.