Someone paid you in crypto. Do you have to pay taxes? – Sun of San Bernardino

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Taxpayers have always shown remarkable creativity in minimizing their tax obligations. Lately, many have been lured by the promise of generating massive wealth while escaping the clutches of the taxman through the lure of decentralized currencies and crypto transactions, otherwise known as cryptocurrency.

Crypto represents an extension of centuries-old practices of barter and cash trading, allowing individuals to transact anonymously and operate within a framework of decentralized systems.

What’s new is that crypto uses blockchain technology, a digital method of recording transactions that makes it nearly impossible to alter, hack, or manipulate the transaction log.

Blockchain is not just reserved for shady transactions or underground economies, as the technology is not inherently illegal. A blockchain is like a ledger on a spreadsheet shared between many computers where sales and purchases of currencies are recorded. Anyone can see the data, but they can’t corrupt it.

The decentralized nature of blockchain poses unique challenges for governments and regulators, allowing individuals to circumvent banks and brokerages to obfuscate financial transactions and potentially avoid taxes. According to a May 2022 report from Barclays, the IRS loses around $50 billion in tax payments per year from unreported crypto transactions.

The explosive growth caught the attention of the IRS. Potential taxpayers’ money at stake has led to increased regulations for filing and paying taxes. The IRS in March 2021 said it had assembled a team of experts to conduct what has been dubbed “Operation Hidden Treasure” to audit crypto investors, according to a Forbes article.

Here is a summary of how cryptocurrency transactions are taxed.

Cryptocurrency, like cash, can buy goods and services, exchange for other cryptocurrencies or assets, or sell against traditional government-trusted currencies like the dollar (also known as fiat currencies). ).

In a popular example, Alex and Brady from YouTube channel Cruisers Academy made a video about how a fan gave them a single bitcoin which they used to buy a 42ft sailboat.

How crypto is different from cash

Unlike paying cash, when you spend cryptocurrency it is considered a taxable event. I don’t pay taxes if I buy something from you for $100 cash. You could, but I don’t. If I used cryptocurrency instead, it would become a taxable event.

On your taxes, you must report the date you acquired and disposed of the coin, the price at which you acquired it, the fair market value of the crypto at the time of disposal, and any resulting capital gain or loss. .

The difference between the cost base (the amount you originally acquired the cryptocurrency for) and the fair market value when you spent, traded, or cashed it in determines whether you have a capital gain or loss.

If you have a capital gain, you may be required to report and possibly pay taxes on the appreciation in value. You may be subject to long-term or short-term appreciation rates depending on whether you held it for less or more than a year.

For example, when Alex and Brady bought the sailboat, if the bitcoin they used was a gift and the value increased between when they acquired it and when they used it to buy the boat, they should declare a capital gain.

In addition to reporting crypto gains and losses, the IRS states that you must include income if you were paid for goods or services, including cryptocurrency “mining,” equal to its fair value. merchant when you received the currency.

Here’s another example of how taxes work.

In February 2011, a tax protester offered an unnamed CPA individual 1,500 bitcoins which traded at $1 per bitcoin (at the time) to prepare for his taxes. The CPA refused.

If the CPA had accepted the position, he would have reported $1,500 of self-employment income on his taxes for payment in bitcoins. If the CPA had held the bitcoin and cashed it out this week, he would have received $38,618,745 in cash. They would then pay long-term capital gains on the difference of $38,617,245. The highest rate of long-term capital gains is 20% plus 13.3% state taxes.

What happens if I don’t report?

On Form 1040, the IRS asked, “At any time in 2022, did you receive, sell, send, exchange, or otherwise acquire a financial interest in any virtual currency?

Intentionally checking the “no” box instead of the “yes” box to conceal taxable events involving crypto could be criminal. A conviction can result in a maximum prison sentence of three years and a maximum fine of $100,000. Penalties and interest would also be assessed on unpaid taxes.

If you didn’t know you had to report your crypto transactions or if you forgot, you can file an extension on the previous year’s reports.

What can I do to minimize the tax?

If you hold the cryptocurrency for more than a year, you may benefit from long-term capital gains tax rates, which are lower than short-term rates.

Tax loss harvesting involves the strategic sale of assets, including cryptocurrency, that have declined in value (resulting in a capital loss) to offset capital gains, which could reduce your overall tax liability .

Direct donation of appreciated cryptocurrency may result in a charitable deduction equal to the fair market value of the donated cryptocurrency at the time of donation. Because you didn’t sell crypto, there are no capital gains. This strategy allows you to support a cause while potentially reducing your taxable income.

By using a self-directed Individual Retirement Account to invest a small portion of your retirement, if the risk is acceptable, you may be able to defer capital gains tax and enjoy tax-free growth.

Given the complexity of cryptocurrency taxation, seeking advice from a tax specialist specializing in cryptocurrencies can be very beneficial. Crypto also has its own language. To learn more about crypto slang, visit crypto.com/university. (An example: “cryptosis” refers to someone who can’t stop talking about crypto.

Michelle C. Herting is a CPA, Certified Business Appraiser and Certified Estate Planner. She specializes in succession planning, business valuations and trust settlements.

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