Large regulatory bodies, as well as investors, have long since taken notice of the income generated by crypto holdings. How will investors navigate this novel protocol during the tax seasons to come?
According to the 2014 S&P Global Financial Literacy Survey, only 57% of US adults are considered financially literate. In a country that does little to prepare its youngest generations to exist within a complex financial system, it is no surprise that cryptocurrency adoption rates are so low among the general population. While universal adoption of cryptocurrency is clearly on the horizon, a Pew Research study reports that only 16 % of Americans say they have ever invested in, traded, or used cryptocurrency.
Ignorance Is Far From Bliss
Another study showcased by Yahoo, reported that 98% of a group of 1000 people, surveyed across the USA, Mexico, and Brazil, don't yet grasp the rudimentary elements of bitcoin, stablecoins or NFTs. With an uneducated majority, the odds are stacked against those who have been left in the dark about the importance of blockchain technology and cryptocurrency.
Large regulatory bodies have recognized the emerging importance of crypto in the modern landscape, and they have been laying the groundwork to oversee (and cash in on) the profits of this multi-trillion dollar industry. 2021's bull run awarded many investors with some decent gains. Now come tax season, many are left with more questions than ever on filing their returns.
No Filing Left Unturned
As the saying goes, "the only 2 certainties in life are death and taxes."
The IRS treats virtual currencies, like bitcoin and NFTs, differently from other investments. In 2014, the IRS issued Notice 2014-21, 2014-16 I.R.B. 938, explaining that virtual currency is treated as property for Federal income tax purposes. Tax compliance law includes a requirement for transfers of at least $10,000 of cryptocurrency to be reported to the IRS.
What is Virtual Currency?
The IRS defines Virtual currency as a digital representation of value, other than a representation of the U.S. dollar or a foreign currency ("real currency"), that functions as a unit of account, a store of value, and a medium of exchange.
A Taxable Event
Purchasing cryptocurrency or an NFT, using FIAT currency, on its own isn't considered a "taxable event."" You can buy and hold cryptocurrency without any taxes, even if the value increases. If your only transactions involving virtual currency during the past year were purchases of virtual currency with real currency, you are not required to report this in your taxes.
If you purchase goods or services with cryptocurrency, that transaction counts as a “sale” of that crypto. This means you'll owe capital gains taxes if your coins have increased in value over what you originally paid for them. And what's more, you'll also owe any applicable sales tax.
The Internal Revenue Code and regulations also require taxpayers to maintain records that are sufficient to establish the positions taken on tax returns.
As a rule of thumb you should maintain records documenting:
- Receipts
- Sales
- Exchanges
- Other dispositions of virtual currency and the fair market value of the virtual currency.
"There is no excuse for taxpayers continuing to fail to report the income earned and taxes due from virtual currency transactions," said IRS Commissioner Chuck Rettig.
Time is of the Essence (Short-Term vs. Long Term Selling)
Holding onto a cryptocurrency for one calendar year before using it to purchase or selling it for profit, would subject you to Long Term capital gain taxes on your earnings. Long-term capital gains are taxed according to varying thresholds; scaling from 0%, 15%, or 20%. If the virtual currency is sold before the one year mark, you are subject to Short
Term capital gains taxes. Short-term capital gains are taxed at the rate of your ordinary income. This rate is as high as 37% in 2021, and is dependent on your tax bracket.
The Hunt For Tax Havens
As with any law, there will always be those who try to live outside of it. In May 2021, a northern california court authorized "Service of John Doe Summons Seeking Identities of U.S. Taxpayers Who Have Used Cryptocurrency." This subpoena of information solicited from the platform Kraken, is a clear indication of more stringent reporting requirements.
With so much money at stake, and the cracking down of the IRS on crypto earnings, a minority of investors have taken seemingly drastic measures to reduce or eliminate their tax liability.
Crypto In Paradise
Puerto Rico, an island famous for its beautiful beaches and 0% capital tax gain obligation, has become a hub for investors looking to conserve their earnings. If investors spend 6 months (183 days to be exact) as a resident of the island, you are free of your capital tax obligations.
Yet, these tax benefits certainly come at a price. Grocery items on the island are 25.4% more expensive than in the United States. Home prices are also reportedly breaking records on the island, skyrocketing 3x their past value, particularly in most desirable parts of San Juan.
Plan B: Renounce Your Citizenship?
New companies have emerged to satisfy the desires of this niche population: crypto millionaires desperate to keep their fortunes intact. The company Plan B Passport has stepped in to offer its clientele a path to a curated foreign passport, catering to those facing steep tax obligations. Their 7 options include tropical tax-havens that are exempt from capital gains taxes on crypto assets.
Many of Plan B's American clients report that they plan to renounce their U.S. citizenship altogether; or are considering this option for later in life. One anecdote recounts one client's reasoning of paying $180,000 for a passport, as it represented only 1% of his net worth, yet the capital gains taxes on his crypto earnings would amount to millions.
While this approach may seem drastic, unprecedented fortunes call for unprecedented measures.
