The cryptocurrency was born with the philosophy of removing the central authority and giving power to the users. The recognition of the crypto assets by governments brings the question about paying taxes to these central authorities back on the table. What are the most important tax implications when it comes to cryptocurrency and where should you start? Look no further, as we have prepared the easy guide for you.
Of course, the tax obligations and laws vary from country to country and each case should be examined separately. However, we will try to guide you through the most important nuances there are when it comes to crypto taxes. Please note, this is not tax or legal advice but a narrative about where to start. Learning about crypto tax obligations in your country is important because it will protect you from tax fines and cumbersome tax audits from the authorities.
Two Types of Income
The value stored in your digital wallet may increase, however, the tax that applies to it varies depending on the source of the income. The crypto income can be divided into two different types.
1. Capital Gains
In 2014 the U.S. tax officials recognized cryptocurrency as equivalent to real fiat money and said it should be regarded as an asset. Moreover, using the cryptocurrency to pay for purchases or for any services also has to be taxed.
Capital Gains are an extra income or profit that you have earned on the trading activity. Imagine you have bought Bitcoin for $9,000 and have sold it for $10,000, then the profit of $1,000 will be regarded as a capital gain and taxed accordingly. The time for how long you had the Bitcoin on your account is also important- if you have held the Bitcoin longer than a year, then the long-term capital gain tax applies, which is usually lower than the ordinary capital gain tax that applies to the transactions with a holding period for less than 365 days. The long-term holding period is getting much better tax treatment in some jurisdictions and can get as little as 0% to discourage speculative trading activity.
The capital gain is usually progressive, if the income made is little, then the tax rate will be smaller, whilst if the profit is in millions of dollars, then the tax rate will be much higher.
It does not matter what fiat money, NFTs, or other tokens you have traded, the key is to translate all profits in the U.S. dollar terms using the exchange rate that was on the date of the transaction.
When it comes to the DeFi exchanges that have issued their own tokens -Liquidity Pool Tokens (LPTs), supplying or extracting liquidity can be interpreted as trade deals and token swaps, hence need to be taxed.
The NFTs can be compared to fine art or collectibles, therefore an even higher rate of tax may apply.
2. Regular Income
With regular income, it is a bit trickier, as depending on the income you have to fill out different forms. For example, getting paid in crypto is considered a salary and is subject to income taxes. Mining is also falling under this category. The lending deals on the DeFi platforms would earn the interest and the tax will be paid on the interest income equivalent in fiat money terms.
Reporting the Transactions
In 2019 the U.S. Internal Revenue Service (IRS) has sent out more than 10,000 letters to cryptocurrency owners suspecting they have failed to report their income from the transactions. It does not matter which broker you use, or the cryptocurrency exchange- if they are compliant with the U.S. regulation, then they report to the IRS all transactions that they facilitate (usually when there are more than 200 trades). The IRS can’t access the data from U.S.-based or offshore crypto exchanges, it is reported to Internal Revenue Service to comply the U.S. laws. Coinbase or Robinhood, who are compliant will not only report the trading activity to the IRS but also will supply the users with ready-to-report tax forms based on their residency.
Some exchanges do not prepare the tax forms, so in order to correctly report all your capital gains, the key is to make a summary of all trades from all trading platforms in one place. Also, do not neglect to report the losses, as they would give you tax reductions in the current or future tax year. This could be done manually or using the special tools designed for this purposes or cryptocurrency tax software such as CryptoTrader, CryptoTax Calculator, Koinly, TokenTax, and many more.
When it comes to capital gains, what scenario triggers the tax reporting requirement? There are three main taxable events.
1. Trading cryptocurrency for conventional money.
2. Trading one virtual currency for another.
3. Purchasing services or goods using virtual currency.
When you have bought a cryptocurrency and then sold it for more, then the profit is subject to tax, regardless of whether you have withdrawn it from your trading account or not.
On the other hand, if you have bought a Bitcoin, for example, and it has increased in value, whilst you were hodling it, you do not need to pay tax, because this is considered as an unrealized gain. Only after you sell the Bitcoin you will pay tax on this profit, not on the actual value of the Bitcoin at the time of the transaction.
In some asset classes, there is a possibility to defer the tax payment if the investor has reinvested the profit in the same asset class. In some jurisdictions, like in the U.S., this is not possible as the IRS has explicitly stated that the taxes should be paid based on the date of transaction.
Crypto Tax Friendliness Geography
It is not a secret that some jurisdictions are Crypto-friendlier than others. This applies not only to an open mind about the activities and accommodative laws and regulations but also to taxes on the crypto income.
So, let’s examine what nations are more crypto tax-friendly than the others:
Portugal is one of the most welcoming crypto tax havens of Europe. It does not recognize the cryptocurrency as a means of payment, meaning it is not taxing any trading profit, nor ordinary income received in crypto. It offers several options to become a tax-resident for Europeans, but also for non-Europeans, including the “crypto visa”.
Malta, also known as “crypto-island”, for some time already ago introduced regulations for blockchain companies. It does not charge individuals a capital gain tax who make a profit from long-term trading activities. However, corporations and short-term trading are subject to tax.
Estonia does not charge taxes for mining cryptocurrencies.
Germany will not charge any taxes on virtual currency profit if the person had the assets on his or her account for more than a year. Furthermore, capital gains under €9,408 are tax-free for individuals as well.
While the spelling is similar the contrast in meaning is crucial when it comes to tax evasion or tax avoidance. Tax evasion is illegal because it means you are not paying taxes you’re supposed to pay while avoiding the large tax bills is makes sense perfectly as we are trying to maximize our own profits. Individuals and corporations are able to choose the tax residency that would help them maximize their crypto income. This probably would not make sense if the income is a couple of thousands, but if profit constitutes large amounts, this could be an option.