The longest-held sentiment among crypto enthusiasts is that Bitcoin and other cryptocurrencies will one day be recognized as a medium of exchange by governments. If that were to happen, it would not only accelerate the maturation of the cryptocurrency market but also promote world-wide adoption of virtual currencies.
Unfortunately, tax authorities, particularly Internal Revenue Service (IRS) in the United States and Australian Taxation Office (ATO), regard cryptocurrencies as assets or intangible properties and not a currency since it’s not issued by a central bank. The asset classification of cryptos means that all gains and transactions made using cryptocurrencies are subject to property taxation principles.
How are Cryptocurrencies Taxed?
To avoid landing in the bad books of the law as a cryptocurrency user/investor, it’s necessary to understand the very instances in which crypto taxation laws take effect. This way, you’ll be in a position to report income and pay the resulting tax correctly.
For starters, tax authorities have made it mandatory for users to report all their cryptocurrency transactions no matter how negligible they seem. These transactions include the purchase, selling of, investing in, or paying for goods and services using any digital currency.
Merchants or businesses that accept payments in the form of cryptocurrencies are required by the law to report the value of the received cryptos. The value should be expressed as their fiat currency equivalent at the time the payment was received. In these cases, as a cryptocurrency user, you’ll incur capital gains, either long-term or short-term.
For the investors, taxable gains apply if the digital currency’s market value increases from the time of investment up to the time of tax filing. A taxable loss, on the other hand, applies when the fair market value is lower than the adjusted basis of the virtual currency.
Additionally, cryptocurrency miners are subject to cryptocurrency taxation. For instance, after successfully mining Bitcoins, you ought to include the fair market value of the mined coins in your annual gross income. Wages paid in cryptocurrency are also taxed based on the fair market value on the coins on the date of receipt.
Note that failing to comply with the tax laws can result in penalties, high interests, or even criminal prosecution. As such, it’s advisable to maintain an accurate record of all your crypto transactions.
It is important to acknowledge that in some countries, cryptocurrencies aren’t classified as property. This, however, doesn’t mean that they aren’t taxed. On the contrary, they are subjected to a different type of taxation policies. Let’s take a quick look at how various countries approach digital assets:
- The European Union
A few years ago, the European Court of Justice ruled that Bitcoin can be exchanged without VAT in the European Union. Although this judgment doesn’t mean Bitcoin is recognized as a legal tender in any of the EU countries, it places Bitcoin on a level playing field with other traditional currencies.
While the VAT exemption applies to all countries in the European Union, cryptocurrency transactions are still subject to other forms of taxes, such as capital gains. For instance, in France, crypto-to-crypto transactions aren’t taxed, but when exchanged for fiat currency, the income tax law applies. Also, if a cryptocurrency is used to acquire an asset or service, VAT is applied.
- The United Kingdom
In the UK, the law isn’t quite clear about cryptocurrency taxation. One thing is certain, though, all virtual currencies are treated as foreign currencies, and as such, they’re subject to tax gains and losses. The UK tax authority, Her Majesty’s Revenue, and Customs states that each crypto transaction will be judged based on its own individual facts and circumstances. So, users may be subjected to a variety of tax policies depending on how they use the crypto.
What to Consider When Planning Your Cryptocurrency Taxes
As far as crypto taxation is concerned, there are several measures you can take if you hope to remain on the good side of the law. These include:
- Make use of Tax Tools
Maintaining cryptocurrency tax compliance requires accurate record-keeping of all transactions. This may not be a big deal to casual traders and investors who engage in minimal crypto transactions. But, for active cryptocurrency traders and miners, it makes sense to invest in software programs to help you track and record the numerous transactions. Some of these tools can calculate your tax liabilities, prepare, and even file your tax returns.
- Donate Your Cryptos
Donating a percentage of your crypto investment reduces your tax liability. Once you have donated your digital assets, the charitable fund sells them to an exchange for fiat cash. Consequently, you enjoy tax relief in that particular year of donation.
- Be Mindful of the Holding Period
Short term gains taxes apply when you hold your cryptocurrency investment for less than a year, while long term gains taxes apply when you hold your investment for more than a year. Depending on your investment goals, these two periods can work for or against you.
Cashing out your cryptos too soon subjects you to frequent short term gain taxes that may eat into your profits. At the same time, holding your investments for too long results in accumulation of long term gain taxes, which might also take a massive chunk off your returns.
Ideally, you should aim to strike a balance between holding for the short term and the long term. If the earned returns are enough to cover the taxes, then you may consider cashing out. If the returns aren’t enough, then consider holding your investments for a bit longer.
- Record Your Loss Too
Just like any other investment, the crypto market doesn’t always offer high returns all-year-round. Luckily, tax authorities are aware of this fact, which is why they allow investors to file tax losses to offset gains. So, be sure to record any losses incurred as a result of market trends.
Cryptocurrency taxation is a rather intricate affair given that the regulatory framework governing the taxation process differs significantly depending on the jurisdiction. As such, consulting a cryptocurrency tax advisor when planning for your taxation is highly recommended. It’s also a good idea to keep tabs on the taxation authority to stay updated on any change of policies or new rules.