Cryptocurrency Tax Laws: An Overview

As a decentralized, international, and virtual payment method, cryptocurrency occupies a unique and often confusing place in the economy. While generally referred to as currency, cryptocurrencies are often traded similarly to stocks and other securities. On the other hand, the SEC has determined that crypto is not a security in itself. 

As crypto becomes increasingly popular, with 16% of Americans having used it at least once, more users will have to grapple with the complicated tax laws surrounding its use. This page will explain the basic tax obligations that cryptocurrency holders have, whether they are investing in, trading, or being paid with crypto.

How the IRS Views Cryptocurrency

Since cryptocurrency is decentralized and exists only virtually, the IRS does not consider it currency. Instead, they view crypto as a “digital asset” or a virtual representation of actual monetary value. However, this designation does not exempt crypto from tax obligations.

The IRS views digital assets as property and taxes them accordingly. Rather than being taxed as currency, crypto is taxed based on the amount of money it represents. The value of cryptocurrency changes frequently, but the IRS calculates taxes based on its value at the time that the taxpayer received it.

Cryptocurrency as Income

Digital assets like cryptocurrency are taxed either as income or capital gains, depending on how the taxpayer obtained them. If you received cryptocurrency as payment, it would be subject to the federal income tax of 10% to 37%, depending on your tax bracket. If you received the crypto in exchange for a one-time service rather than as part of a formal employment agreement, you still must report it as income.

Crypto can be fairly volatile, and its value at the filing time may differ from when you received it. When reporting your cryptocurrency income, use its value at the time that you received it to calculate how much you owe.

Failure to pay federal income tax is penalized by a fine of 0.5% of the unpaid tax per month that it went unpaid. Failure to report and pay income tax is penalized by a 5% fine.

Cryptocurrency and Capital Gains

Capital gains are profits earned from the sale of property. The IRS views the exchanging of crypto for any other property, such as fiat currency or another form of crypto, as capital gains, provided that the taxpayer receives more value than their initial investment.

If you purchased $100 worth of cryptocurrency and sold it for $200, you would report $100 of capital gains. You would also have to report those capital gains if, instead of exchanging the cryptocurrency for fiat currency, you exchanged it for $200 worth of a different cryptocurrency. You would also owe the appropriate capital gains tax for those $100.

Your capital gains tax will differ based on how long you hold your cryptocurrency. If you held it for under a year before selling, the IRS will consider your capital gains to be short-term, and they will be taxed at the same rate as your income. If you hold it for longer than a year, your capital gains will be long-term, and you will owe a separate tax of either 15% or 20% based on your income. 

You are exempt from the capital gains tax if your annual income is less than $41,675 if you are single, $83,350 if you and your spouse file your taxes separately, or $55,800 if you are the head of your household.

Cryptocurrency and Capital Losses

If your cryptocurrency holdings have decreased in value since you first purchased them, you may be able to claim capital losses on your taxes. If your capital losses exceed your capital gains, you can deduct the net loss from your income, which will, in turn, lower your taxes. You cannot deduct more than $3,000 in capital losses in a given year. Instead, any losses past $3,000 will roll over into your taxes for the next year.

Like capital gains, capital losses can be either short- or long-term. If you sold or exchanged your crypto less than a year from the day after you purchased it, you would deduct the loss from your short-term capital gains. If you held your crypto for more than a year, you would subtract from your long-term capital gains. Finally, you would compare your net short and long-term gains/losses against each other.

For example, if you purchased $1,000 worth of cryptocurrency and, less than a year later, sold it for $500, you would report $500 in long-term capital losses. If, in that same year, you sold crypto that you purchased a few months earlier for $300 more than you initially paid, you would report $300 in capital gains. Overall, you would have experienced a net capital loss of $200, which you would deduct from your taxable income.

Gifting Cryptocurrency

The IRS provides several tax exemptions for assets exchanged as gifts, defined as any property given without expecting commensurate goods or services in return. While gifts are technically taxable, the IRS does not impose that tax on gifts whose monetary value falls below an annually-adjusted exclusion rate. In 2023, that exclusion rate is $17,000, meaning that gifts of cryptocurrency that fell below that benchmark at the time they were exchanged are nontaxable. Cryptocurrency gifts are also nontaxable if they are transferred between spouses or given as political donations.

The person who gives a gift is responsible for the gift tax unless they and the recipient have already agreed that the recipient will pay. If you received cryptocurrency as a gift, you most likely do not have to report it on your taxes, even if it exceeds the exclusion rate. However, you may want to consult a tax attorney to ensure that the crypto constitutes a gift.

If you sell crypto that you receive as a gift, you will have to report capital gains or losses.

Cryptocurrency as Charitable Contribution

The IRS allows you to deduct cryptocurrency donated as a charitable contribution from your taxable income so long as the amount does not exceed 50% of your annual income. For example, if your yearly income is $50,000 and you donate $1,000 in cryptocurrency to a charitable cause, you will only have to pay taxes on $49,000 of your income.

What Happens If I Don’t Pay Taxes on Cryptocurrency?

If you fail to pay taxes on the cryptocurrency gains and income that you reported, you will be fined 0.5% of what you did not pay per month that went unpaid. However, if you wait longer than 10 days to repay your missed taxes after being notified, the fine will increase to 1%.

Failing to file your taxes incurs a harsher penalty of 5% per month. If you fail to file and report your taxable crypto earnings, you will only be subject to the 5% penalty. If you need more time to file, the IRS allows you to apply for an extension.

Both of these penalties are subject to interest if you take too long to pay them.

Do I Need a Tax Attorney if I Didn’t Pay Taxes on Cryptocurrency?

If the IRS claims that you owe unpaid taxes on cryptocurrency, it is a good idea to consult a tax attorney immediately before paying. It is possible that the IRS made an error and overrepresented how much you owe. They may have failed to account for a capital loss, calculated a gift of cryptocurrency as income, or otherwise mistaken nontaxable crypto as taxable.

An attorney with a strong background in tax law can go over the IRS’s claim alongside your taxes and ensure that you are not being asked to pay any more than you owe. You can use expertise.com’s lawyer directory to find a well-regarded tax attorney in your area.