The Internal Revenue Service (IRS) has introduced a broader “Digital Assets’ category to replace the ‘Virtual Currency’ category ahead of the 2022 tax year. This change is included in the newly released draft of the 2022 IRS tax form.
Page 16 of the draft tax form defines ‘Digital Assets’ as “any digital representations of the value recorded on a ‘cryptographically secured distributed ledger or any similar technology.”
Cryptocurrencies and stablecoins were already taxable as they fell under the ‘Virtual Currency’ category, which the IRS defined as a digital “that functions as a unit of account, a store of value, or a medium of exchange.” Per the latest released document, crypto investors must also report taxable income on any NFT they might have sold, gifted, exchanged, or transferred in 2022. Considering this is just a draft, the IRS could still make alterations before releasing the official tax instructions for the year.
Crypto Taxes In The United States Of America
Following the introduction of the ‘Virtual Currency’ section in 2021, American taxpayers must file tax returns to the IRS on income made from digital tokens such as cryptocurrencies and stablecoins. As such, crypto investors need to maintain records and understand the crypto tax laws and the implications of every crypto transaction. Below is a guide to understanding crypto taxes in the U.S.
Firstly, it is important to keep a record of all crypto transactions and report them, although the crypto exchanges will also make them known to the Tax Authorities. Failure to report these crypto transactions on your part could lead to an audit by the authorities, which could lead to fines and penalties. Records are also important as they make it easier to calculate crypto earnings and losses when filing these tax returns.
How Are Crypto Profits Taxed?
The United States Internal Revenue Service (IRS) treats crypto profits as capital gains income. Crypto investors and traders that have ever made a profit and had to pay tax on traditional capital assets like bonds and stocks will understand the concept of crypto tax since the IRS also considers cryptocurrency a property. Persons that make crypto profits will similarly pay capital gains taxes to how taxes are paid on gains from stocks and bonds.
How To Calculate Crypto & NFT Profits?
Determine the asset’s selling price and subtract the original value or cost price. Simply put, the profit is the difference between the selling and cost prices when trading a crypto asset. Furthermore, crypto tax liability will depend on how long the crypto trader holds the coin, whether or not it is up to a year. Why does that matter? The taxpayer would pay short-term capital gains tax if they kept the coin for less than a year. Short-term capital gains tax ranges from 10% to 37% in the U.S, depending on the income range. On the other hand, the taxpayer pays a more favorable long-term capital gains tax if they have held the crypto asset for more than a year. Long-term capital gains tax varies between 0%, 15%, or 20%, depending on the income range.
Does Digital Asset Tax Only Apply To Investments?
Crypto tax does not only apply to investments. It also concerns crypto enthusiasts who didn’t purchase or trade crypto as an investment. Several crypto uses are under the tax radar. Using crypto to purchase goods and services or converting one crypto to another should be included on tax returns.
Individuals who are paid in crypto must report the income to the IRS. This situation could also get dicey when reporting tax returns if such a person chooses to hold the coin and it increases or decreases in value. Crypto Miners are not exempted as they would likely pay business income tax instead of capital gains or personal income. In such instances, Tax authorities will tax the profits made by the Miner, and the person would be allowed to itemize deductions such as business costs before taxing the remaining profits.
Does One Pay Tax For Purchasing Digital Assets?
Certain transactions will not incur a tax liability, and purchasing crypto is one of them. Buying crypto is not taxable because there is no immediate gain or loss. However, there is tax liability as soon as one sells the asset and obtains money or another digital asset. What happens is that there is a potential or realized profit from the sale, which makes it a taxable event.
Moving one’s coins between wallets or exchanges has no tax implication. There is nothing to tax since a sale hasn’t occurred. Likewise, receiving a crypto gift has no tax implications. However, one will need to pay tax if it exceeds $15,000. If the individual further decides to sell the crypto gift, they will use the cost price as when the person originally bought the coins. That will determine the profit made from the sale of the coins.
How Is The IRS Enforcing Digital Asset Tax?
The Authorities have realized the huge potential in the Crypto industry and keep developing mechanisms to enforce Crypto taxation. The IRS requires taxpayers to answer questions relating to crypto activities on Tax Form 1040. The questions include whether or not one has received, sold, gifted, exchanged, or has any interest in any digital token. These questions have huge implications and cannot be taken with levity.
Taxpayers need to answer those questions genuinely, as lying could have serious consequences besides tax compliance issues. Lying could bring about potential fines and other penalties, as mentioned earlier.
As part of its efforts to ensure Crypto Tax enforcement, the IRS launched ‘Operation Hidden Treasure’ to crack down on crypto non-taxpayers. The IRS put together a task force that is highly skilled in tracking down the various ways crypto investors make money from the industry. The task force addresses issues such as “structuring,” whereby an individual breaks down his transactions to avoid going above the $10,000 threshold and evading specific cash tax reporting requirements. It will also pay attention to Shell Corporations that help individuals hide their crypto gains and the use of Crypto Blockchain Cloaking Technology.
Can I Write Off Crypto & NFT Losses?
One can take a deduction for capital losses to reduce crypto taxes. This deduction is similar to what applies when paying taxes on stocks, bonds, and other traditional investment instruments. Crypto investors can offset some of the capital gains by reporting their capital losses. Furthermore, they can enjoy up to $3,000 annually in capital losses. They can also push the remainder of losses above $3,000 to future tax returns so that it can be deducted from gains they might make in the following year.
How will NFTs Be Taxed?
The newly released draft tax form indicates that the IRS will also tax NFT investors and traders similarly to the crypto tax. This move puts more focus on NFT projects and trading. Project founders are subject to business tax when selling their NFT collections to investors and traders. They would be allowed to itemize their business costs as part of the necessary deductions before the IRS taxes the remainder of their profits.
Purchasing or minting an NFT would have no tax implications, but selling it would attract a capital gains tax. Here, the profit will be the difference between the selling price and cost basis, and that is what is subject to tax.
Digital asset taxes can be straightforward for some people, but they can get dicey and technical depending on the transactions. Generally, the complexity will depend on how involved one is in the web 3 space. Irrespective, It is essential to exercise due diligence as simple transactions could also have significant tax implications.
Tax will keep exploring new avenues and regulations to tax the crypto industry as it grows exponentially. They will also pay more attention to tax enforcement, and we could see tougher punitive measures to ensure tax compliance.
Cryptocurrency firms and exchanges should employ the services of tax professionals and compliance officers who guide them as they navigate the complexities of Crypto Tax. Also, everyone should keep detailed records of their digital asset trades and transactions.
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