The taxation of crypto assets and cryptocurrency is complex and constantly evolving, creating a challenging landscape for investors, founders, and employees of crypto-focused companies. In this guide, we’ll cover everything you need to know about crypto taxes in the United States for 2023 and how to best minimize your tax liability, including:
- Crypto-to-Crypto Transactions
- Crypto Lending
- Airdrops and Forks
- Gifts and Donations
- IRS Tax Forms for Crypto
- Estimated Quarterly Taxes on Crypto
- Best Practices for Minimizing Crypto Tax Liabilities
The Many Types of Crypto Asset Transactions
In the United States, crypto assets and cryptocurrency are categorized as property by the Internal Revenue Service (IRS) for tax purposes. As such, crypto investments are subject to capital gains taxes, just like publicly-traded stocks. Capital gains taxes are triggered by taxable events, such as buying and selling crypto assets, receiving staking and mining rewards, and more, all of which we’ll discuss in this guide.
Before diving into the specifics of each taxable event, remember that capital gains are taxed in one of two ways, and rates are adjusted based on your income:
- Long-term capital gains tax: 0% to 20% when held for more than one year
- Short-term capital gains tax: 10% to 37% when held for less than one year
As you navigate through the various sections of this guide, you’ll gain a better understanding of the tax implications associated with each of these types of transactions, helping you maintain compliance with IRS regulations and minimize your tax liability.
When you exchange one crypto asset or cryptocurrency for another (e.g., selling Bitcoin to purchase Ethereum), the IRS considers this a taxable event, and you will be subject to capital gains taxes. The concept is similar to buying and selling stocks in a taxable brokerage account. Additionally, selling a crypto asset for fiat currency, such as US Dollars, also incurs capital gains taxes.
To calculate capital gains or losses from a crypto-to-crypto transaction, establish the cost basis of the original asset, which includes the amount you initially paid and any platform fees. Subtract the cost basis from the fair market value of the new asset at the time of the exchange. The resulting amount represents your capital gain or loss on the transaction.
Crypto mining is the process of validating and adding new transactions on a blockchain network. Miners are often compensated with newly minted crypto assets, and in the United States, this revenue is considered taxable income. The tax rate applied to mining income depends on the individual miner’s overall taxable income and filing status. Mining rewards, as they are crypto assets themselves, will also be subject to capital gains taxes if and when they are sold or exchanged.
Staking involves locking up a certain amount of crypto assets in a wallet to support the operations of a blockchain network, such as validating transactions or securing the network. Staking rewards, typically paid in the form of additional crypto assets, are considered taxable income and subject to capital gains taxes when sold or exchanged.
Non-fungible tokens (NFTs) are unique digital assets that can be bought, sold, or traded on various platforms. When you sell or trade NFTs, the gains are subject to capital gains tax, just like other crypto assets. If you create and sell NFTs as part of a business, the income may be subject to self-employment tax.
Crypto lending allows investors to lend their cryptocurrencies to borrowers through decentralized finance (DeFi) platforms, which facilitate transactions and often provide higher interest rates than traditional lending options. Interest earned from lending is subject to ordinary income tax. As with traditional loans, borrowers do not owe taxes on the loaned amount.
Decentralized finance (DeFi) platforms offer various financial services, such as lending, borrowing, and trading, without intermediaries like banks. Transactions involving DeFi platforms may be subject to capital gains taxes or ordinary income taxes, depending on the transaction’s nature. It’s crucial to maintain detailed records of your DeFi activities for accurate tax reporting.
Airdrops and Forks
Airdrops occur when a crypto platform or project distributes free crypto assets to users, often as a marketing strategy. The fair market value of the newly acquired crypto at the time of receipt is considered taxable income and must be reported to the IRS.
Forks involve changes to a blockchain and come in two forms: hard forks and soft forks. Hard forks create a new, separate crypto asset and result in the distribution of new crypto to existing holders of the original asset. Like airdrops, the fair market value of the new tokens received in a hard fork is considered taxable income. Soft forks represent updates or changes to the existing blockchain protocol. Soft forks do not result in the acquisition of new crypto assets and therefore do not have direct tax implications.
Gifts and Donations
Crypto gifts are subject to different tax rules depending on the situation. If you receive a crypto asset or cryptocurrency as a gift, you generally do not need to pay taxes on it until you sell, exchange, or otherwise dispose of it. For the person giving the gift, there may be gift tax implications if the value of the gift exceeds the annual gift tax exclusion.
Donations of crypto assets to qualified charitable organizations are typically tax-deductible. However, specific rules and limits may vary based on the value of the donation and the recipient organization.
Record Keeping and Tax Reporting
There are many different tax forms required for reporting crypto transactions to the IRS. Here are some of the tax forms you will see in 2023:
IRS Tax Forms for Crypto
- Form 1099-B: The Form 1099-B summarizes your transactions when submitting your tax return. Make sure to review these forms for accuracy and include the relevant information on your tax return. Some crypto exchanges may also issue a Form 1099-K if you have a high volume of transactions within one year.
- Schedule 1: Taxpayers must report all crypto-related income on their tax return, including capital gains and losses, on their Form 1040 and accompanying Schedule 1. This includes reporting proceeds from crypto sales, mining and staking rewards, airdrops, and any other taxable crypto transactions.
- Form 8949 and Schedule D: To report capital gains and losses from crypto transactions, you must complete Form 8949 and transfer the totals to Schedule D. This includes providing detailed information about each transaction, such as the date acquired, date sold, cost basis, and proceeds.
- Schedule C: If you operate a crypto-related business, such as mining or trading, you must report your income and expenses on Schedule C. This includes calculating your net profit or loss, which is then reported on Form 1040 and Schedule 1. Be sure to include all relevant income, deductions, and expenses related to your crypto business activities to ensure accurate reporting.
Estimated Quarterly Taxes on Crypto
The IRS may require some taxpayers to pay estimated quarterly taxes on their income, including income from crypto transactions. This applies to individuals who expect to owe at least $1,000 in taxes when filing their return or if their withholding and refundable credits will not cover at least 90% of the tax owed for the current year.
If you expect to owe a substantial amount in crypto taxes, understand and plan for your quarterly tax obligations to avoid potential penalties. Calculate your estimated quarterly tax payments using Form 1040-ES, or submit payment on the IRS website.
Best Practices for Minimizing Crypto Tax Liabilities
There are several strategies that can help you minimize your crypto tax liabilities and ensure you stay in compliance with the IRS.
Here are a few best practices:
- Hold onto your crypto investments for more than one year: By holding onto your crypto investments for more than a year, you will be able to benefit from a long-term capital gains tax rate.
- Make use of tax-loss harvesting: Tax-loss harvesting is a strategy that involves selling crypto assets that have experienced a loss in value to offset capital gains from other assets. By strategically selling these underperforming assets, you can potentially reduce your overall tax liability.
- Plan for Quarterly Tax Payments: As mentioned earlier, some taxpayers may be required to pay estimated quarterly taxes on their crypto-related income. If you expect to owe a significant amount in crypto taxes, it’s essential to understand and plan for your quarterly tax obligations to avoid potential penalties.
- Consult a Tax Professional: Crypto tax laws are complex and always changing. It’s always a good idea to consult with a Harness Tax Advisor or other tax professional who is knowledgeable about crypto taxation to ensure you’re in compliance with the latest regulations and taking advantage of any potential deductions or credits.
Harness Wealth Can Help
Navigating the world of crypto taxation is a challenging task, and it’s important to have a tax advisor on your side who truly understands the crypto landscape. At Harness Wealth, our advisors specialize in crypto and other complex asset classes, and are available to help you with everything from tax questions to comprehensive financial planning.
If you have crypto assets and need help understanding the tax implications of your investments, schedule a call with a Harness Tax Advisor today.
Tax services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth”. Harness Wealth Advisers LLC is an internet investment adviser registered with the Securities and Exchange Commission (“SEC”). Harness Wealth Advisers LLC solely acts as a paid promoter for unaffiliated registered investment advisers. Harness Wealth Advisers LLC’s registration as an investment adviser with the SEC does not imply a certain level of skill or training.
This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, the reader is encouraged to consult with the professional advisor of their choosing.
Risks Relating to Digital Assets: There are certain risks relating to digital assets, virtual currencies, cryptocurrencies and/or digital coins/tokens (collectively, “Digital Assets”). The investment characteristics of Digital Assets generally differ from those of traditional securities, currencies, commodities. Digital Assets are not backed by a central bank or a national, international organization, any hard assets, human capital, or other form of credit and are relatively new to the marketplace. Rather, Digital Assets are market-based; a Digital Asset’s value is determined by (and fluctuates often, according to) supply and demand factors, its adoption in the traditional commerce channels, and/or the value that various market participants place on it through their mutual agreement or transactions. The lack of history to these types of investments entail certain unknown risks, are very speculative and are not appropriate for all investors.