Cryptocurrencies are digital assets that live on the blockchain. These digital assets do not exist physically but are entirely virtual.
The decentralized ledger technology used by cryptocurrencies, particularly blockchain technology, enables cryptocurrencies to function independently of governments and central banks. This allows a peer-to-peer payment system that lets anyone send and receive money anywhere.
In recent years, the market value and acceptability of cryptocurrencies have greatly increased. It comes as no surprise that the increasing value of cryptocurrencies throughout the years have presented investors with numerous opportunities. As of writing, the global crypto market cap is at $1.09 trillion. With the rapid cryptocurrency ecosystem development, authorities are now becoming more involved.
With its popularity increasing, it is important for investors to understand the taxation implications of trading and investing in cryptocurrencies.
Understanding the taxation of cryptocurrencies is essential for legal compliance, financial planning, pushing adoption, and fostering innovation. In general, individuals and businesses are also protected from any legal and financial consequences by understanding and adhering to tax legislation.
Disclaimer: Most cases stated pertain primarily to US regulations only, as of this writing, there is no clear stance on these matters in the Philippines.
Contrary to popular belief, cryptocurrency is classified by the IRS as an “asset” and not as a form of “currency.” This means that any gains or losses from trading or investing in cryptocurrencies are subject to capital gains tax in the United States. Capital gains tax is a tax on the profit you make when you sell a capital asset. This is similar to selling traditional securities, like stocks or mutual funds. For those who own cryptocurrency, this develops significant complications since it exposes them to more intricate tax laws.
Cryptocurrency earnings from mining and airdrops should all qualify as regular taxable income. Cryptocurrency "mining" is the process of using computers to solve challenging equations and store data on the blockchain. You could be compensated for this effort with crypto tokens. On the other hand, an “airdrop” is when a cryptocurrency project gives out free digital assets to several wallets. At your marginal income tax rate, commonly known as the percentage of tax you pay for the additional income earned above a specific threshold, taxes must be paid on the whole value of the cryptocurrency on the day you receive it.
You are also responsible for paying taxes on any gains made, even when you trade or convert cryptocurrencies – such as when you switch Bitcoin for Ethereum.
Moreover, if you used cryptocurrency in exchange for purchasing products/goods, even though you technically spent the crypto and not sold it, you’d still owe capital gains taxes on the value of the crypto.
Here’s an example: You bought a crypto asset worth $300. The crypto you’re holding then increased its value to $1000. You used this to buy $1000 worth of items. Consequently, you still owe capital gains taxes on the $700 profit you realized.
Despite all these, there are also ways to minimize your cryptocurrency taxes. Here are a few tips you may consider:
Tax rates on long-term capital gains are lower than those on short-term capital gains. The gain is seen as long-term if you keep the cryptocurrency for more than a year and are taxed at a reduced rate.
The good thing about crypto taxes is that you don't owe taxes on cryptocurrency sales or purchases made at a loss. Taxes are only due if you use it or sell it for a profit. These losses may then be used to offset gains from other holdings. This method of reducing tax obligations on other assets is commonly known as "tax-loss harvesting."
If you only plan to hold your crypto, you have fewer worries about crypto taxes. Holding cryptocurrency does not generate a tax liability in and of itself, as long as you don’t sell it for a profit.
Donating cryptocurrency to charity can help minimize your taxes by allowing you to take a tax deduction for the fair market value of the cryptocurrency, and by avoiding capital gains tax on any appreciation in its value.
Suppose you bought a certain cryptocurrency for $17,000 during the first quarter of the year, and now it’s value has increased to $30,000, resulting in a gain of $13,000. If you plan to sell this, you would owe capital gains tax on the increase in value. But if you donate this cryptocurrency to an eligible charity, you can deduct the full fair market value on your taxes and even avoid the capital gains tax applied to this. Fair market value refers to the cryptocurrency’s worth in a fair and open market.
Taxation in the area of cryptocurrencies is complicated and changing quickly. To avoid consequences, it is important to keep accurate records of all cryptocurrency transactions and to report all cryptocurrency-related income on your tax return. Just like any other field, tax law violations concerning cryptocurrencies can have a significant impact, such as fines, penalties, and in some circumstances even criminal charges.
Lastly, complying with cryptocurrency taxes may also show your dedication to upholding the law and can help you build a solid reputation for potential future possibilities, including taking part in Initial Coin Offerings (ICOs) or other cryptocurrency-related projects.
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