Every bitcoin transaction either bought, sold, or traded comes with tax consequences.
The Internal Revenue Service (IRS) has ordered the Coinbase cryptocurrency exchange deliver all the essential data involving the transactions made by more than 14,000 of its customers that bought, sold, sent, or bought above $20,000 worth of bitcoins (BTC) between the year 2013 and 2015, The IRS seems well prepared to scrutinize and levy all the necessary taxes, and penalties, on bitcoin dealings. Although this development is a big surprise to the proponents of the cryptocurrency, it is essential to understand that charges are imminent, irrespective of the method of dealings and the asset classes.
Few essential pointers that will assist in preparing tax returns for filers who purchased or sold cryptocurrencies.
There are numerous brokers, exchanges, and intermediaries, that are involved in cryptocurrency trading. However, none are mandated to make available tax reports to market participants; a few may decide to do so at their discretion. Example, Coinbase does provide a “cost basis for taxes” report.
Individuals are responsible for maintaining the necessary records regarding their cryptocurrency transactions.
For example you six months ago, you bought ten bitcoins at the rate of $4,000 each or might have received them a payment for a job completed. The bitcoins may currently worth $8,000 each, thereby having a potential profit of about $5,000 a coin.
You must have the necessary records showing that you received them at the time when they were worth $3,000, and hence your net income is $5,000 per coin. Failure in maintaining details of such transaction data and documents may cause your holding to be assessed at the current value of $8,000 each, significantly increasing your tax burden.
Any transaction in bitcoins may be subject to tax. For example, you received five bitcoins six years ago, and spent one at a boutique four years back, another two was spent buying goods online three years ago, and sold the remaining two and received the equivalent dollar amount a month back. For each of such transaction on their different dates, you are expected to keep the equal dollar value for each and record your net dollar income from bitcoins. Your tax liability will be computed accordingly.
For an accurate record, it is crucial to understand how different dealings of cryptocoins are taxed. Varying on the kind of bitcoin dealing, here are the several situations that should be kept in mind for tax preparations:
a. If bitcoins are received as a means of payment for goods or services provided, the holding period is not relevant. They are taxed and are being reported, as ordinary income. The federal tax on that type of income may vary from 10 % to 39.6%. State income tax may also be applicable.
b. If bitcoins are received from bitcoin mining, it is also considered as ordinary income. Moreover, self-employment tax may be required to be made on such receipts.
c. If cryptocoins are obtained from a hard fork exercise, or via other activities such as airdrop, it is also treated as ordinary income.
d. If bitcoins are purchased as an investment and sold at a gain, the holding period determines the treatment of such dealing. If held below a year, the net receipts are treated as ordinary income, which may as well be subject to additional state income tax.
e. If the holding period is for above a year, it is considered a capital gains and may attract an extra 3.8% tax on net investment income.
If you have donated your cryptocoins, such as bitcoin or ethereum, to qualified charities, then you may be eligible for the reduced tax liability.
For example, in the year 2017, the Fidelity Charitable fund received bitcoin donations of about $22 million. The method of operation of the charitable fund ensures that the earned bitcoins are instantly sold on the Coinbase exchange. The equivalent dollar amount gotten from such a sale is invested depending on the donor’s choice, who benefits by getting a tax deduction in the year of such donation.
It should be noted that only crypto coin donations made to qualified charities are considered for such deductions. Selling the tokens and giving out the dollar amount will not cut down your bitcoin tax burden. Also, the deductions are accessible for individuals who detail their tax returns.
Income obtained from bitcoin transactions should be published in the Schedule D, which is an attachment of form 1040. Depending upon the transaction type, which decides the kind of income from cryptocurrencies such as ordinary income or capital gain, the revenue should be reported under the correct heading in the proper columns of the form.
