So you are sitting on the hottest cryptocurrency around, and as the end of the year approaches, maybe you finally start thinking about (gasp!) that dreaded taxman.
Yep, just because your digital currency gains didn’t come with a W-2 or a nice holiday card from your stockbroker, doesn’t mean you don’t have to worry about taxes if you made money from cryptocurrency in 2017, like many of us did.
Bitcoin Cryptocurrency Tax – Does It Apply To Me?
The recent news that Coinbase is being forced to turn over records of its customers to the I.R.S came as a shock to some cryptocurrency holders, who may have thought (incorrectly) that they didn’t owe taxes on all those gains, and are now panicking.
Unfortunately, whether you made profits off of stocks, beanie babies, rare Star Wars collectibles, real estate, or just about any other asset, Uncle Sam is always waiting with his hand out if you are a United States citizen.
Do you think the notorious gangster Al Capone went to prison for murders, bribery, robberies, or selling bootleg liquor? Nope, he went to prison for tax evasion, nothing else. When it comes to citizens making money, the IRS doesn’t care how you did it, they just want their cut. So remember, no matter what your views are about cryptocurrency or how it isn’t like fiat money and the government can’t control it, that doesn’t mean you aren’t responsible for reporting and paying taxes.
Common Bitcoin Tax Questions
Below are some examples and a quick primer on 2 main tax issues facing people who’ve made money off the huge run-up in many cryptocurrencies in 2017.
A disclaimer; these are just general rules, in a new area of taxation that the rules are still not clear-cut, so do your own diligence, and be aware of changes to the laws before April 15th.
The tax code is thousands of pages thick, with exceptions to the exceptions, so treat these as a general starting point to your tax questions. Also, I am a tax lawyer, but not YOUR tax lawyer, so all this is information is provided “as-is”, and is not investment or legal advice.
Question: No Money – Am I Going To Prison?
Help, I got some coins years ago and they are now worth a billion dollars, but I have no cash in my bank account to pay taxes, am I broke or going to tax prison?
Answer: No… Probably Not
No, probably not. First, we outlawed debtor’s prisons a long time ago. Not paying taxes is generally a civil issue, not a criminal one, and the tax year still hasn’t ended yet, so even though the government wants cash instead of crypto to pay tax bills, you probably aren’t past due yet anyways.
Second, and more importantly, you don’t owe a dime of taxes on crypto gains until those profits are “realized” in tax speak. What this means is, that if you are sitting on your now-higher-valued cryptocurrency, but have never sold or transferred it, than no taxable event has occurred. You haven’t actually recognized any profits in hand yet, so you don’t owe any taxes on it.
A basic rule of profits on any asset is; you don’t have to pay taxes on the increase in value of the asset until you sell it. This should make sense as it applies to things like houses (you don’t owe more income tax on your residence going up in value each year that you don’t sell it in) or stocks (you don’t have to calculate your taxes every day when the stock market closes at a different number than the day before).
So even if you acquired 100 coins worth a dollar each 7 years ago, if you haven’t sold or transferred any of those coins yet, you don’t owe any taxes on them yet either. If you do sell or otherwise transfer them before December 31st, then your 2017 tax forms are supposed to reflect those gains. If you wait until after January 1st to sell or transfer, then you don’t have to report or pay any taxes until your 2018 tax year. Until you realize a gain, you do not owe taxes on your cryptocurrency profits.
Question: How Much Do I Owe?
I sold some of my crypto during the year, how do I know how much tax I even owe?
Answer: It Depends
Like all great taxation questions, the answer to this is of course; It Depends. Cryptocurrency doesn’t have its own special unique tax rate, so the amount you owe depends on factors that include what marginal tax bracket you are in, when you sold it, and how much profit you made over your cost to obtain it. If you made very little total income this year (i.e. you are at the lowest income bracket), your marginal tax rate may be anywhere from 0%-10%. Likewise, if you made millions in 2017, whether from cryptocurrency, your job, or any other source, you are probably at the highest tax bracket, currently 39.6%.
It’s important to understand that these are just marginal rates applicable to you as an individual, and that assets (like cryptocurrency) often qualify for a better rate, known as the capital gains rate.
Capital gains rates apply to things that make you money, from something other than your daily work (which is called “ordinary income”). While wages from a career are taxed at the higher ordinary income marginal rates, money you make from the assets you own qualify for the typically lower capital gains rates. You also get to deduct the cost of the asset (called “basis”) from your profits.
There are short-term capital gains rates (which are often the same as the ordinary income rates now) and long-term capital gains rate (either 0%-15%, or 20%). Obviously, you want your crypto-profits to qualify for that long-term rate. In order for an asset to qualify for the LT capital gains rate, you must hold it for at least a year.
Bitcoin Tax Examples
Example 1: Joe, a guy in the top marginal tax bracket, bought 1 bitcoin for $1,000 in March 2017, and sold it for $10,000 in November 2017. From this $10k, he gets to deduct his basis ($1k), for a total profit of $9k. Because he held the asset for less than a year, it only qualifies as a short-term capital gain, so Joe pays the same rate as his ordinary income rate. At a 39.6% rate on a $9,000 profit = $3,564 taxes due. Ouch.
Example 2: Jake, a guy in the top marginal tax bracket, bought 1 bitcoin for $500 in June 2016, and sold it for $10,000 in November 2017. From this $10k, he also gets to deduct his basis ($500), for a total profit of $9,500. Because he held the asset for more than a year, it qualifies as a long-term capital gain, so instead of paying the 39.6% rate, Jake gets to pay the long-term capital gains rate instead. At a 20% rate on a $9,500 profit = $1,900 taxes due.
Despite making more profit, Jake owed far less tax than Joe!
Final Thoughts On Cryptocurrency Taxes
The difference between paying long-terms capital gains rates and ordinary income rates is huge, so someone who owns cryptocurrency should be aware of the value of recognizing gains on currency held more than a year whenever possible. This isn’t always possible, but if you acquired cryptocurrency at different times at different rates, pay attention to which coins you are selling, it could cut your tax bill nearly in half simply by documenting that the profits are from the coins you held more than a year. If you are thinking of selling some appreciated crypto (realizing your gain, in tax lingo), pay close attention to the calendar to see if you can save some money by classifying it as a long-term asset.
These will hopefully help point you in the right basic direction if you were worried about your crypto tax bill, and didn’t know where to start. There are far-ranging complex questions about how taxable transactions from trading cryptocurrency should be documented and tracked, and how to best structure crypto-related transactions to maximize tax efficiency, this is only the beginning.
For example, what if you paid someone in cryptocurrency, or traded one altcoin for another altcoin but never sold it, how will the IRS treat these transactions? Stay tuned, cryptocurrency finance and taxation is still in its infancy, but there is no better time to start thinking about the future than now.