Understanding Cryptocurrency Taxation
In the United States, cryptocurrencies are treated as property for tax purposes. This means that any gains or losses earned from buying, selling, or trading cryptocurrencies are subject to capital gains tax. The tax rate on cryptocurrency profits depends on several factors, including the holding period of the cryptocurrency and the taxpayer’s income level.
Holding Period
The holding period is the length of time that a taxpayer holds a cryptocurrency before selling it. If a taxpayer sells a cryptocurrency after holding it for less than one year, the profit earned from the sale is considered short-term capital gains and is subject to ordinary income tax rates. If a taxpayer holds the cryptocurrency for one year or more, the profit earned from the sale is considered long-term capital gains and is taxed at a lower rate.
Income Level
The tax rate on cryptocurrency profits also depends on the taxpayer’s income level. For the 2021 tax year, the tax rates for ordinary income are as follows:
- 10% for incomes below $9,950
- 12% for incomes between $9,950 and $40,525
- 22% for incomes between $40,526 and $86,375
- 24% for incomes between $86,376 and $165,851
- 32% for incomes between $165,852 and $209,425
- 35% for incomes above $209,425
For long-term capital gains, the tax rates are as follows:
- 0% for incomes below $9,950
- 10% for incomes between $9,950 and $399,750
- 20% for incomes between $400,000 and $446,875
- 37% for incomes above $446,875
Example
Let’s take an example to illustrate how the tax rate on cryptocurrency profits works. Suppose a developer bought Bitcoin (BTC) for $10,000 in January 2021 and sold it for $100,000 in December 2021. The holding period of the Bitcoin was 11 months, which qualifies as long-term capital gains.
If the developer’s income level is below $9,950, they would not owe any taxes on the profit earned from selling the Bitcoin. If their income level is between $9,950 and $399,750, they would owe 10% on the profit, which in this case would be $10,000 (10% of $100,000). If their income level is between $400,000 and $446,875, they would owe 20% on the profit, which in this case would be $20,000 (20% of $100,000). If their income level is above $446,875, they would owe 37% on the profit, which in this case would be $37,000 (37% of $100,000).
Consequences of Not Paying Taxes on Cryptocurrency Profits
Failure to pay taxes on cryptocurrency profits can have serious consequences for crypto developers and other taxpayers. The IRS has been cracking down on cryptocurrency tax evasion in recent years, and penalties for not complying with tax laws can be significant.
Penalties
The IRS imposes a penalty of 5% on any unpaid taxes if the taxpayer fails to file their tax return on time. This penalty applies for each month that the taxpayer is late in filing, up to a maximum of 25%. In addition, the IRS can impose penalties of up to 25% on any underreported taxes owed.
Audits
The IRS has been increasing its audits of cryptocurrency transactions in recent years, and failure to keep accurate records of cryptocurrency transactions can make it difficult to prove the taxpayer’s position. In some cases, the IRS may require the taxpayer to pay taxes on unreported cryptocurrency profits, even if they no longer have access to their original cryptocurrency holdings.
Legal Consequences
In some cases, failure to pay taxes on cryptocurrency profits can lead to criminal charges. For example, in 2019, the IRS charged a Florida man with evading more than $4 million in taxes by failing to report his profits from trading Bitcoin and other cryptocurrencies. The man pleaded guilty and was sentenced to three years in prison.
Case Studies: Real-Life Example
s of Cryptocurrency Taxation
Case Study 1: Investor Sells Bitcoin for a Profit
In 2017, an investor bought Bitcoin (BTC) for $10,000 and sold it for $100,000 in December of the same year. The holding period of the Bitcoin was less than one year, so the profit earned from the sale was considered short-term capital gains and was subject to ordinary income tax rates.
If the investor’s income level was below $9,950, they would owe 10% on the profit, which in this case would be $10,000 (10% of $100,000). If their income level was between $9,950 and $399,750, they would owe 22% on the profit, which in this case would be $22,000 (22% of $100,000). If their income level was above $400,000, they would owe 35% on the profit, which in this case would be $35,000 (35% of $100,000).
Case Study 2: Investor Sells Bitcoin for a Loss
In 2018, an investor bought Bitcoin (BTC) for $10,000 and sold it for $5,000 in December of the same year. The holding period of the Bitcoin was less than one year, so the loss earned from the sale was considered short-term capital losses.
If the investor’s income level was below $9,950, they would not owe any taxes on the loss. If their income level was between $9,950 and $399,750, they could deduct up to $3,000 (the greater of 10% of their adjusted taxable income or their actual short-term capital losses) from their taxable income.
Case Study 3: Crypto Developer Sells Ethereum for a Profit
In 2020, a crypto developer bought Ethereum (ETH) for $1,000 and sold it for $5,000 in December of the same year. The holding period of the Ethereum was less than one year, so the profit earned from the sale was considered short-term capital gains and was subject to ordinary income tax rates.
If the developer’s income level was below $9,950, they would owe 10% on the profit, which in this case would be $2,000 (10% of $20,000). If their income level was between $9,950 and $399,750, they would owe 22% on the profit, which in this case would be $4,400 (22% of $20,000). If their income level was above $400,000, they would owe 35% on the profit, which in this case would be $7,000 (35% of $20,000).
Conclusion
Cryptocurrency taxation is a complex area that requires careful attention from developers and other taxpayers. Failure to comply with tax laws can have serious consequences, including penalties, audits, and even criminal charges. It’s important for crypto developers and other taxpayers to understand how the tax rate on cryptocurrency profits works in practice and to keep accurate records of their cryptocurrency transactions.
