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Introduction to Crypto Tax Regulations: A Comprehensive Guide



Introduction to Crypto Tax Regulations: A Comprehensive Guide

It is only the first quarter of 2022, but it is already evident that this will be yet another landmark year for the crypto space as we have so far seen how cryptocurrency can play an instrumental role in key events such the ongoing Russia-Ukraine war.

There has also been a steady increase in global crypto adoption with over 300 million crypto users spread across the globe. Interestingly, that number is predicted to hit 1 billion before the end of 2022, according to crypto.com’s latest ‘crypto market sizing’ report which measures crypto adoption worldwide.

It was also noted that more than 16% of Americans were involved in some form of cryptocurrency deal or transaction last year, a percentage which is expected to blow up in the coming years.

However, with the crypto space making major headlines, did you know that Crypto transactions are now taxed? Don’t worry if you were not yet aware, we are here to tell you all about it. 

Many users are oblivious to the fact that many governments like the USA are starting to implement tax regulations over crypto transactions. If you reside in one of these countries, you’re probably wondering how your trades and other crypto activity will impact your taxes. Well, buckle up, because you’re in for a ride!

Understanding DAE and Tax Regulations

As far back as 2019, the IRS began sending mail to taxpayers. This mail, termed “educational letters”, was sent to approximately 10,000 people suspected of owing tax payments to the Federal government for carrying out virtual currency transactions.

This raised eyebrows and a particularly prominent question: were cryptocurrency transactions no longer anonymous? This seemed to be the case as it became apparent that the federal agency had based its list of recipients on customer data acquired from cryptocurrency exchange Coinbase. 

In fact, over the years, many have seen Coinbase as the “snitch” of cryptocurrency exchanges as they indulge in many practices that go against the core values of cryptocurrencies. Ultimately, this meant that those who do not correctly report their crypto income could face penalties, interest, or even criminal prosecution, as the IRS warned.

Transparency with Cryptocurrency

Bitcoin, the first cryptocurrency, was launched in 2009 as a peer-to-peer payment system and was created to be simple to use, store, and be relatively anonymous. Held bitcoin and virtual wallets were therefore as anonymous as the contents of a Swiss bank account.

It wasn’t long before officials saw an increase in cryptocurrency-based money laundering. The fact that such “secret” wealth was difficult, or nigh impossible to tax was bound to draw the attention of tax officials eventually.

As the space continues to evolve, the majority of cryptocurrency transactions are now open to the public, largely being stored on public ledgers. As a result, in an attempt to escape the wrath of regulators and tax officials, cryptocurrency exchanges, especially centralized platforms, started implementing anti-money laundering rules on Bitcoin dealers.

Whether bitcoin should be classified as a currency or a commodity remains a major debate among regulators, central bankers, and federal courts. Regardless, everyone appears to agree that profits earned from its trade and utility should be taxed.

So, how does this affect traders? At the present time, Bitcoin exchanges do not provide 1099 forms to their customers to assist them with their taxes. Blockchain-based tools, on the other hand, are available to assist cryptocurrency investors in recording transaction data and tracking their taxable transactions.

How Crypto Taxation Works

According to an IRS notice published in 2014: “If cryptocurrency is used to purchase something, it is considered to be worth its fair market value in U.S. dollars at the time of the transaction.” Likewise, “If cryptocurrency is sold or exchanged at a profit, that profit is taxable at the capital gains rate.” These two clauses outlined the premise for how crypto taxation works. Let’s consider some examples below.

Cashing Out Cryptocurrency

Your taxable earnings (or losses) in bitcoin are recognized as capital gains and losses, as with any other asset. When trading cryptocurrencies for fiat money, such as the U.S. dollar, traders will need to know the virtual coin’s cost basis.

For instance, if you purchased Bitcoin for $7000, and sold it for $9,000 eight months later, you would owe $2,000 in short-term capital gains taxes. The proceeds from the sale of assets held for less than a year are taxed at the individual’s regular tax rate, much like earned income. For the 2022 tax year, this rate ranges from 0% to 37%, depending on the taxpayer’s income.

If the same deal happened a year or more after purchasing the bitcoin, one would instead owe long-term capital gains taxes. For the 2022 tax year, that would be 0%, 15%, or 20%, depending on your total taxable income.

Cryptocurrency Mining

Cryptocurrency miners have their own set of regulations. In this case, crypto miners validate cryptocurrency transactions and add them to the blockchain. This is considered labor by law, and miners are paid for it.

Their pay, however, is considered business income and is therefore taxed accordingly. Miners can also deduct the costs associated with mining activities, such as equipment and utility costs, leaving the remainder as profit to be taxed by regulators.

Using Cryptocurrency to Make Personal Purchases

For users who often trade cryptocurrencies and use it to buy products and services, keeping track of tax owings on purchases made with fractions of a virtual coin is slightly more complicated. First, they must figure out which coin was used to purchase a cup of coffee, and then keep track of the coin’s price basis and value at the moment of purchase.

This only works with transactions involving a coin that has been profitably sold however. Transactions cannot be labeled as a loss. If a trader buys a bitcoin for $350 and then spends a fraction of it to buy a pair of pants when that same bitcoin is worth $100, the transaction can’t be declared as a loss.

Buying and Selling Cryptocurrencies

Investors are also exposed to taxes when exchanging one cryptocurrency for another.

Users will owe taxes based on the difference in the bitcoin’s value between when it was acquired, and when it was spent on the acquisition of other crypto assets such as Ethereum.

Taxes on Cryptocurrencies: Keeping Track

Many exchanges make it easier for crypto traders to keep track of this data by providing free exports for all trading data. This can be used by the trader or their tax advisor to figure out how much tax the trader owes.

Platforms for blockchain solutions can also be utilized to obtain this information and highlight significant tax areas of interest. Smart-contract-based wealth management services, such as those offered by ‘TrustVerse’, organize a user’s digital identity and assets on the blockchain to guarantee that tax and estate duties are properly addressed.

When attempting to file Bitcoin taxes for the first time, it is usually preferable to consult a trained accountant as crypto assets are increasingly being studied by CPAs and other tax specialists.

For the time being, the IRS is allowing taxpayers to adjust to the new taxation requirements by providing guidance for revising previous tax returns with regard to cryptocurrencies. Savvy traders have already satisfied their obligations and are now focused on tackling the crypto market for the coming year without the looming cloud of uncertainty hanging over them.

What Does Crypto Taxation Mean for Other Components of DAE?

Well, we have good news for NFT buyers and sellers – there is currently no guidance or regulation for any tax implications for sales or earnings performed in the metaverse yet, though the keyword here is “yet”.

Much of this stems from the fact that tax offices are always playing catch-up. They, like most of us, haven’t fully grasped the concept of the metaverse, and therefore have had a hard time providing clear advice for crypto transactions, let alone the tax consequences of selling the NFT of an in-game name.

We don’t yet know if the same crypto tax regulations will be applied here, or if an entirely different set of rules will be drafted related to the treatment of metaverse property tax, income, and so on.

We do know, however, that unless an exception is specifically made, all sales transactions in the U.S. are deemed taxable. So, what kind of tax could be imposed on metaverse income, assets, and other things?

Metaverse-NFTs Taxation

Tax assets are tokenized as NFTs in the metaverse, but the IRS and other taxing authorities have yet to provide much guidance on exactly how NFT taxation should be categorized.

Nevertheless, most tax experts believe that NFTs are a form of art, specifically digital art.

When art is sold in the physical world, artists are required to pay a 28% capital gains tax on the high-end collectibles. The same could therefore be applied that the sale of digital assets in the metaverse, like property, apparel, or names in fiat currencies may be subject to the same 28% capital gain tax.

But what if NFTs are exchanged for cryptocurrency? 

There are, in a way, guidelines for this. A “crypto to crypto” trade is treated as a sale by the IRS, and is thus liable to capital gains tax. Therefore, you’ll have to pay capital gains tax on any profit made from the sale of an NFT in ETH, for example, which is more likely.

It’s unclear whether this would be the collectible CGT rate or the usual short and long-term CGT rates.

Metaverse Income Tax

To add to the confusion, each metaverse has its own currency, whether it’s SAND, MANA, or something else altogether. Many users are now earning money in-game, which they are then able to sell or exchange for fiat currency, or a different cryptocurrency outside of the game.

Completing quests, renting land, having a job, or even – for a true ‘Inception’ moment – playing a game to earn money are all examples of methods of acquiring money.

There is a precedent for metaverse income being taxed, although the situation is a little tricky.

‘SecondLife’ is a virtual reality game which burst in popularity a few years ago. In the game, players could earn ‘Lindens’, the game’s virtual currency, though they are not a type of cryptocurrency. Lindens are a closed-loop virtual token that can only be spent or used in-game. However, Lindens can be sold for USD on SecondLife‘s LindeX market.

The fact that currencies used in metaverses such as ‘The Sandbox’ and ‘Decentraland’ have so much more applicable real-world uses suggests that they’ll be taxed similarly. So, if you’re generating extra money in the metaverse, such as by routinely creating and selling NFTs, you may be required to pay federal income tax on it, even if it’s entirely in crypto.

Some tax specialists are attempting to stay ahead of the curve by assisting taxpayers in navigating the complexities of metaverse taxes. Prager Metis has even established a CPA company in Decentraland, claiming that its metaverse office would act as a resource for people and enterprises seeking accounting and financial advisory services, including on taxation.

Conclusion

Alas, all good things must come to an end, and this article is no exception. Crypto taxation, which we could never have imagined a couple of years ago, has become a reality, and a complex one at that. 

Thankfully, we have listed the different scenarios in which crypto taxation may be applicable; and if you fall into any of the above categories it may be high time you reviewed your crypto tax compliance.

Finally, while many may argue that taxing anonymous transactions should not even be a topic of discussion, others have argued that without it, cryptocurrencies would not be able to find a place in the real world, much less achieve its objective of replacing fiat currency. What do you think about crypto taxation in the decentralized economy? Please leave your thoughts in the comments section below.

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