With that said, it’s important to have the information you need to make sure your taxes are calculated correctly. You’ll also want to consider tax-planning techniques you can use to try to minimize the taxes you pay on bitcoin.
The IRS and Cryptocurrency
The IRS treats cryptocurrency—like bitcoin—as a capital asset. It has indicated that virtual currency doesn’t have status as legal tender in any jurisdiction. It’s referred to as “convertible” virtual currency if it has an equivalent value in real currency, or if it ever serves in place of real currency. It can be exchanged into another currency, either real or virtual, and it can be digitally traded.
When Do You Have To Pay Taxes on Bitcoin?
Because the IRS treats bitcoin as a capital asset, it is subject to general tax principles. If you invest in bitcoin and then sell or trade it for a higher price than you bought it for, you owe capital gains taxes. If you own bitcoin and use it to make a purchase, that is also considered selling it, so you will have to pay capital gains taxes if the bitcoin you own is worth more than what you paid for it when you bought it. If you’re paid in bitcoin for goods or services, you must include the fair market value of the bitcoin you in U.S. dollars in your gross income. Transactions using virtual currency should be reported in U.S. dollars, too. As with other types of assets, you would acquire them first, often by exchanging cash for the assets. You then own them for a period of time, and you might eventually sell those assets, give them away, trade them, or otherwise dispose of them. Capital gains taxes come due at this point. Four things may happen if you sell, trade, or no longer own your bitcoin:
Reporting Cryptocurrency on Tax Returns
Cryptocurrency transactions must be reported on your individual tax return or IRS Form 1040. If you engage in any transaction involving cryptocurrency, you must check the appropriate box next to the question on virtual currency, even if you received any for free, including from an air-drop or hard fork. Do not check this box if you only engaged in transactions among wallets that you yourself own.
How Capital Gains Taxes Work on Bitcoin
Suppose you purchased one bitcoin for $30,000. You then sell it for $50,000, so you have a $20,000 capital gain. This would be a short-term gain if you held the bitcoin for one year or less, and it would be taxed as ordinary income according to your tax bracket. It’s a long-term gain taxed at a rate of either 0%, 15%, 20%, depending on your overall income, if you owned the Bitcoin for longer than one year.
The Net Investment Income Tax
You might also find that you’re subject to the net investment income tax that applies to investment income. The tax is due if you’re a single taxpayer, and your overall modified adjusted gross income (MAGI) from all sources is more than $200,000 for the year. The threshold increases to $250,000 for married taxpayers who file jointly and qualifying widow(er)s. It drops to just $125,000 for married taxpayers who file separate returns.
How To Pay Taxes on Bitcoin
Establish a record-keeping system for all your transactions, and keep track of when you acquire and when you dispose of bitcoin. Identify your cost basis method and your exchange rate. Then record the dispositions of bitcoin on Schedule D and Form 8949. Normal capital gains strategies apply: You can offset gains with losses, time your dispositions to qualify for long-term treatment, harvest your losses, and harvest your gains. A tax professional can help you with these concepts. The income is reportable on your personal tax return, normally due April 15 of each year (or a subsequent working day if April 15th falls on a holiday) unless you request a six-month extension from the IRS.
What Happens If You Don’t Pay Taxes on Bitcoin?
Bitcoin is no different from other sources of taxable income or assets. If you shrug your shoulders at the IRS and don’t pay taxes on bitcoin transactions, even if you didn’t know you were supposed to do so, you’ll be penalized. You’ll be charged interest at the rate of 0.5% of the amount of tax you owe, up to a cap of 25% of the unpaid balance. The IRS additionally has numerous enforcement options for collection, from liens against your property to levies on your income and bank accounts.
Tax Tools for Bitcoin
Casual bitcoin users might want to consider using a reputable bitcoin wallet provider that has implemented risk-mitigation tools to make buying, trading, and selling bitcoin more secure and user-friendly. Even aside from tax considerations, investors should take a look at wallet providers or registered investment vehicles with the kind of security features that one might expect from a banking institution. These tools might come in handy both when you’re handling transactions and when you’re planning for taxes. BitcoinTaxes, the web-based software for importing data and calculating gains/losses, may be helpful as well.
