Bitcoin is the first formal application of blockchain technology, as well as the grandfather of cryptocurrency. As a result, it is a disruptive technology by definition. Bitcoin has created waves in the finance and currency worlds by successfully sustaining a decentralized, yet secure digital money system, just how blockchain technology has disrupted traditional ledger solutions.
Bitcoin does not require the support of centralized entities such as banks. A cryptographic encryption system, on the other hand, serves as the mathematical authority needed to organize and verify transactions. Bitcoin miners use their computers to solve bits of an open-source algorithm that aids in the organization and verification of transactions. This mathematical authority awards miners with Bitcoin in proportion to their efforts in exchange for their hard work.
Miners can then exchange Bitcoin for fiat currency, such as the US dollar, or spend it to purchase goods and services directly.
The link between Bitcoin and the US government is fascinating. It’s understandable that the government would be wary of Bitcoin’s widespread acceptance, given its notorious volatility and superficial associations with the criminal underworld, not to mention the concerns officials must have about entrusting monetary and fiscal policy to what is essentially an algorithm and those who verify transactions (if it ever comes to that).
However, over time, Bitcoin’s resiliency as a network and a currency, as well as the convenience and cost-effectiveness of blockchain payments, have formed a compelling argument for the cryptocurrency. As a result, policymakers have accepted Bitcoin’s slow but significant integration into traditional financial systems.
To begin, cryptocurrency exchanges began pairing Bitcoin with fiat currencies like the dollar. These sites, including as Binance and Coinbase, are still in use today. Bitcoin futures contracts, which are traded on large institutional platforms like the Chicago Mercantile Exchange and the Chicago Board Options Exchange, demonstrate Bitcoin’s growing presence in finance.
Given this acceptance and Bitcoin’s increasing integration into the established economy, it’s only natural that institutional pressures have been exerted on the currency. Indeed, regulators keeping an eye on this newest addition to their ecosystem have had an impact on Bitcoin.
The Internal Revenue Service (IRS) has announced that it is sending out 10,000 instructive letters to taxpayers who it believes owe taxes on virtual currency transactions. It’s probable that the federal agency compiled its list of recipients using customer information obtained from cryptocurrency exchange Coinbase. The IRS warned that those who do not record their income correctly could face penalties, interest, and even criminal prosecution.
Taxes and Bitcoin
While Bitcoin was designed to be anonymous, the majority of transactions are now visible. Governments have already noticed spikes in unlawful market trading using Bitcoin. To avoid regulators’ wrath, exchanges now put anti-money laundering rules on Bitcoin traders.
Taxes, on the other hand, have been the most significant adjustment for Bitcoin traders.
While regulators, central bankers, and federal judges disagree on whether Bitcoin should be classified as a currency or a commodity, they all appear to agree that it should be taxed. Cryptocurrencies are taxed similarly in most major nations.
So, how does this affect traders?
First and foremost, nothing matters unless it is enacted into law. There’s always conjecture about what may happen based on what some financial regulator says, but no single person has the power to define an asset or change the tax code unilaterally, and little has changed since the IRS first addressed cryptocurrencies in 2014.
IRS Notice 2014-21 defines virtual currencies as property in the United States. This means that anything bought with a digital currency will be taxed as a capital gain, whether the asset was held for a short or long time.
For example, if you buy a cup of coffee with Bitcoin that was worth $1,000 when you bought it, you must additionally account for the price of Bitcoin at the time of the coffee purchase. If Bitcoin is trading at $1,200 at the time you buy the coffee, you’ve paid for a dollar-denominated item with another asset that is now worth more in dollars than it was previously. As a result, the Bitcoin you spend for coffee will be taxed according to capital gains rules.
While cryptocurrency brokers aren’t required to provide clients with 1099 forms, traders must report all transactions to the IRS or face tax evasion charges. The following are examples of taxable transactions:
Exchanging bitcoin for fiat money, sometimes known as “cashing out,” is a common practice.
Paying for products or services, such as buying a cup of coffee with Bitcoin.
The process of exchanging one cryptocurrency for another.
Receiving cryptocurrencies that have been mined or forked
According to the IRS, the following occurrences are not taxable:
Purchasing cryptocurrencies with fiat currency
Donating cryptocurrencies to a tax-exempt charity or non-profit
Giving a third party cryptocurrency as a gift
Transferring bitcoins from one wallet to another
How to Work Out How Much You Owe
It’s not easy to figure out how much profit you’ve made and how much you owe in taxes.
When cashing out cryptocurrency for fiat money like dollars, one must know the basis price of the Bitcoin they’re selling, as per regular tax requirements.
For example, if you bought Bitcoin for $6,000 and sold it three months later for $8,000, you’ll owe a $2,000 short-term capital gains tax (equal to income tax). Long-term capital gains taxes according to one’s tax rate are levied if the identical trade occurred over a two-year period. This is 0% for those in the 10% to 15% income band, 15% for those in the 25% to 35% income bracket, and 20% for those in higher income levels.
Selling bitcoins that have been mined rather than those that have been purchased with cash is a different affair. The profit gained from selling mined cryptocurrency is taxed as business income because they are receiving money in exchange for mining inputs that can only be regarded as work (as the phrase “Proof of Work” implies). One can also deduct the costs of their mining activity, like as computer hardware and power.
Purchases made for personal use
Buying a cup of coffee using bitcoin comes with its own set of complications. To calculate the cost of the coffee, first determine the basis price of the Bitcoin used to purchase it, then multiply it by the cost of the coffee.
Currently, if the gain was derived from a personal purchase, such as a cup of coffee, taxpayers can deduct up to $200 per transaction for foreign currency exchange rate gain. A de minimis election is what it’s called. However, there is no de minimis rule that exempts modest transactions, which can result in a complicated tax situation if one is continuously trading cryptocurrency while still using it to purchase goods and services.
Determining which coins were used to acquire the coffee, their basic price, and associated gains, and then repeating this process for each purchase becomes even more difficult if the buyer is also a frequent trader of coins. As a result, it’s critical to remember to save all transaction data for each digital wallet and currency.
The fact that this only works with gains adds to the intricacy. Only capital asset trades or for-profit transactions are eligible for a loss and a tax deduction. If someone buys Bitcoin for $8,000 and then uses it to buy a pair of jeans for $6,000, they cannot claim a loss on their tax returns.
Buying and Selling Cryptocurrencies
Investing in cryptocurrencies also exposes investors to taxation. If you buy Ethereum using Bitcoin, you’re effectively selling it, so you’ll need to report the difference in price between when you acquired it and when you spent it on Ethereum, as well as keep track of the price of Ethereum at the time of purchase for when you sell it later.
Many exchanges assist crypto traders in keeping track of all this data by providing free exports of all trading data, which an accountant (or a diligent enthusiast) may use to calculate their tax liability. Blockchain technologies are also well-suited to storing this information and highlighting tax-related topics of interest. Smart-contract-based wealth management services, such as those offered by TrustVerse, organize one’s digital identity and assets on the blockchain, ensuring that tax and estate duties are met with immutable precision according to the asset owner.
When filing cryptocurrency taxes for the first time, it is usually a good idea to consult a licensed accountant. While tackling a multi-year trading career may sound overwhelming, it is necessary, and it is becoming easier as CPAs and other tax professionals gain a better understanding of crypto assets. For the time being, the IRS is allowing taxpayers to get used to the new system and has produced a tutorial on how to alter old tax returns to incorporate cryptocurrencies. Savvy traders have already met their commitments and are now focusing on the crypto market for the coming year, free of the cloud of uncertainty.