IRS

IRS Tax Demand on Cryptocurrencies – Common Queries Answered

The US Internal Revenue Service (IRS) has requested taxpayers to report virtual currency transactions since the tax season has already started. They have clarified that they are going to treat cryptocurrencies as property for U.S. federal tax filing purposes. However, there are several unanswered doubts in taxpayers’ mind regarding paying tax on cryptocurrencies. It is a complex subject to handle since this is a new asset class and people lack clarity. We have compiled the most frequently asked questions and tried to provide the answers to all of them

Do we need to pay tax for our gains on cryptocurrencies?

Ans: The short answer is: “Yes”. If we have made gains out of selling crypto, we need to pay tax.

If I hold cryptocurrencies without liquidating them, do I still need to pay taxes?

Ans: No. If you are only holding, you need to report them in filing and need not pay tax.

If I hold a cryptocurrency and it doubles in value in a year, should I pay the tax for that gain?

Ans: Since the IRS is going to consider cryptocurrencies as property, you need to treat your coins as properties. For example, If you buy a house and its value shoots up in a year, do you pay tax for the gain? You only pay when you sell the house. So, you don’t need to pay tax, even if the coins double in value. Given these types of tax rules, a long-term hold strategy has far fewer headaches and confusions regarding paying taxes.

What would be the short-term and long-term tax percentage for cryptocurrencies?

Ans: Short-term is considered less than 12 months in the US. 35-40% tax collected on the profit made on selling of Bitcoin or other cryptocurrencies within a year. Bitcoin and other cryptocurrencies come under the highest tax bracket among other assets.

Long-term capital gain is considered to be more than 12 months, and the tax percentage that you need to pay on the gains made is 15%. That is 15 cents to a dollar. So, you save a lot of money if you hold long term.

What would be the difference for a person who comes under the higher tax bracket and the one who comes under lower tax bracket?

Ans : Say, for example, if a person comes under 100K income and if he makes a gain of 5k in Bitcoin, then he should be paying tax on 105K. On the other hand, if a person comes under a lower tax bracket, say 15K, and made a profit of 5K in profit out of Bitcoin, then he only needs to pay tax on 5K. This  condition holds good only if you are trying to sell your Bitcoin and want to reaffirm that the holding does not attract tax. So, the person coming under a higher tax bracket would have to pay a higher tax if he liquidates his holdings.

If I use my cryptocurrency as a payment, do I need to pay tax?

Ans: This is a tricky question and will have to be answered in a very clear manner with an example.

Say, for example, if you have hired a maid and paid her $2000 (0.25 BTC) in Bitcoin for a year of service, and the price of Bitcoin was about $8000 at the time of payment. After a month, if the price crashes to 1000$, you need to pay tax for that price of Bitcoin on that particular day of payment. If your .25 BTC is worth only 250$, because Bitcoin’s price crashed to 1000$, it does not mean that you need to pay tax for 250$. You have to pay tax for 2000$.

If I use my Bitcoin for lending purposes – a system where I get interest payments periodically by giving my coins to someone to hold, what should be my strategy?

Ans: If you are lending your Bitcoins and you receive the interest in coins, then it is highly advisable to liquidate the holdings immediately to USD and pay the tax for that amount. Because if you hold the interest that you received in coins and then if the value collapses, then you need to pay for the price which was there during the time you received the interest and not the interest on the present value. So, you would be struck if you don’t liquidate it to USD and have to pay a lot of tax even if the value of your coin goes down.

If I hold my coins long-term for 18 months and sell them off for USD and invest them in day-trading and lose my money, will I encounter tax?

Ans: If you sell your coins and made X profit in USD and then do day trading and lost money, you still need to pay tax on the profit you made when you sold your bitcoins to USD. It doesn’t matter if you invested in trading and ended up in a loss.

It is highly advisable to keep the profits as coins, instead of converting them to USD since they attract tax. Even if you do several transactions and flip many times between different cryptocurrencies, you need not pay tax, since they remain virtual and all are considered virtual assets.

Can I hide my crypto transactions from the IRS, since it is anonymous?

Ans: IRS is the most powerful tax-collecting agency in the world, and all your transactions are on the public ledger for them to see. The IRS can see all your transactions on the block explorer and find your transactions. So, it is not a good idea to hide your transactions from the IRS and end up getting dragged by them to explain your crypto holdings and the profit that you made on them.

Sometimes you might even be dragged to court by the IRS in extreme cases, and it becomes more complicated. It is not anonymous. One can do reverse engineering to root back and find the transaction history. The IRS is actively looking for tax cheats.

Will the IRS find out, if I use more anonymous and private coins like Monero or Zcash, where the transaction history or the addresses are not made public?

Ans: If you move a large sum of money anywhere on the blockchain, you will leave digital footprints, and it is easy for the IRS to find out about any huge transactions that happen on the internet. Also, while you buy coins from an exchange, you have to provide proof of your identity (KYC). So, the IRS does know that you have bought your coins using an exchange, and there are not enough ways to cheat, even if you are using anonymous coins. The IRS and other authorities in the US can also use forensic tools to track your transactions easily, even if the coin that you were transacting is the most private coin available in the cryptocurrency space.

Even recently, Wikileaks CEO Edward Snowden has revealed in his document that the NSA is tracking all the transactions of Bitcoin holders, and they are keeping a close watch on any huge transactions to avoid any money laundering or terrorist financing. So, it is always advisable to pay the tax to authorities, not only for mere rules or obligation, but also from a moral and ethical point of view.

3 Comments

  1. Well said on tax payments

  2. You obviously have no understanding of what Zcash is and how it works

  3. Do not attempt to tax evade – The IRS is better than you might think.

    With that said, they cannot actually trace Monero transactions. If you send Monero from an exchange to your wallet, and from your wallet somewhere else, there is no trace of it. That’s just how it works.

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