As a general trend, regulators around the world are imposing crypto taxes where crypto is seen as property or a commodity for tax purposes, rather than foreign currency — the tax rate you’ll owe on cryptocurrency transactions will vary by jurisdiction and use. In many countries, this translates to crypto being subject to capital gains tax for most individuals who invest in cryptocurrencies, says Danny Talwar, Head of Tax at Koinly, the crypto tax calculator service. In some jurisdictions, the rates for such tax might seem high.
Crypto Taxes in the United States as a Benchmark
The United States, as custodians of the world’s reserve currency, is at the vanguard of the movement to regulate cryptocurrencies, with crypto taxation high on their list of priorities. In 2014, the Internal Revenue Service issued a rule on digital currency like Bitcoin, saying it treats virtual currencies as property for tax reasons.
Capital gains are the most discussed issue — they are taxed at different rates depending on whether the gain was realized quickly or over a longer period of time (hodling for more than a year), and the individual tax bracket of a taxpayer. One has to keep in mind that the maximum tax rate on long-term capital gains is far lower than that on short-term gains. Thus, the US government offers incentives to people who are willing to keep their crypto assets for a long time.
Whether a person is paid in cryptocurrency via traditional employment, staking, mining, running a node, airdrops, or interest on a loan, they will be subject to income taxes in the United States based on the USD value of cryptocurrency earnings at the time of receiving the digital assets.
Possessing cryptocurrency does not subject you to taxation. If you haven’t yet spent the cryptocurrency stored in your wallet, there is no need to file a crypto tax return. If you sell your digital assets or otherwise create a taxable event, you will have realized a capital gain or loss and will be subject to taxation.
Here a person needs to bring in an element of clarity in the tax treatment — you generally have to understand whether you’ve made a gain or loss when you sell, gift, and exchange crypto, Danny Talwar adds. There are plenty of nuances.
When a taxable event occurs as a result of your crypto activity, you must file a tax report. The following are examples of taxable events related to cryptocurrencies that are mentioned in the IRS’s virtual currency guidance:
- Swapping digital currency for traditional money such as the US Dollar.
- Income from cryptocurrency is taxed like any other kind of regular income.
- A transaction involving the use of cryptocurrency for the acquisition of goods or services.
New Concepts to Create New Taxation
Danny Talwar also stresses the point that since the crypto space has moved quickly in recent times, with many trading NFTs, engaging with DeFi platforms and Play-2-Earn games — new taxation rules are definitely going to be imposed:
“The tax treatment for more complex transactions is still gray in most countries. Often, current reading of tax authority guidance indicates an unmanageable amount of taxable events and disposals. Reviews are being undertaken to provide more clarity, however, this will likely take some time leaving many accountants and crypto holders in the dark.”
In his “Ultimate Crypto US Tax Guide”, Danny provides some examples of new ways one can earn crypto from DeFi, i.e. earning interest through lending protocols like Aave or Compound or earning rewards for staking tokens like SUSHI or CAKE. Theoretically, since users are getting income — they become subject to income tax.
New instruments such as NFTs are also considered by the IRS for the 2023 reporting year.
NFTs are a unique asset class, and it depends on what the NFTs themselves do within the ecosystem, says Cal Evans, digital asset international lawyer — but it is subject to taxation, nevertheless:
“As a usual rule of thumb, if you buy something cheap and sell it for a profit, you can expect to pay taxes if you live in a capital gains jurisdiction. Everyone that lives outside a tax-free jurisdiction is taxed on any NFT sales they make, both as a creator or as a speculative trader. The type and amount of taxes you pay depends on where you live and how you use those NFTs.”
Are Digital Assets Closely Monitored by the Authorities?
The crypto community may mistakenly believe that the decentralized structure of cryptocurrency allows them to easily avoid paying taxes. Starting in 2021, the US IRS receives information on customers and their crypto earnings from popular exchanges like Coinbase in the form of 1099-MISC forms. Also, the government has added a new question to the main US income tax form (1040), which every US taxpayer must answer under penalty of perjury: “During 2021, did you receive, sell, swap, or otherwise get rid of any financial interest in any virtual currency?”
Let’s say the Internal Revenue Service finds out you didn’t declare any crypto revenue. If this happens, an automatic CP2000 letter will be sent to your home to make you aware of your unreported income and tax obligations. Contractors such as Chainalysis are used by the IRS to study blockchain technology in order to drastically reduce tax fraud. Danny Talwar is confident that tax authorities are already upskilling in the crypto space in a bid to keep up with the increasing adoption of crypto, particularly around DeFi, NFTs, and Metaverse concepts. It is likely that they will invest in technology and benefit from clearer regulation to ascertain information on individuals and businesses who seek to evade taxes on crypto.
As the cryptocurrency ecosystem grows, it is likely that the number of tax audits and prosecutions related to cryptocurrency will rise. By April 15, 2023, all US crypto taxpayers from 2022 must file amended returns. By June 15, 2023, all tax correspondence is due.
Investors in cryptocurrencies often overlook the fact that they must pay taxes on any profit they make from their crypto holdings. Instead of hoping the authorities won’t notice, investors in cryptocurrencies should file amended tax returns on their own — it’s better to do this, despite the fact that there are still gray zones. As Danny Talwar hopes, tax authorities will eventually provide clearer guidance in relation to this so that taxpayers can navigate the tax environment with more confidence.
What Is the Best Jurisdiction for Crypto?
Each country has local tax legislation and whilst the general trends move towards a capital gains tax for individuals, there are local nuances to consider for each country. Much of these differences are a result of existing tax law rather than being crypto specific. Nevertheless, step by step, countries are also issuing guidelines on crypto-specific transactions such as airdrops, staking, and lending.
There is never one answer to the question of “most crypto-friendly jurisdiction” as it depends on a number of different factors, states Cal Evans:
“If anyone speaks to a lawyer and they suggest one location, leave the room. For example, as a founder, you have to think about a number of things. Examples include: do you want a license, do you want to pay taxes, do you want to operate in certain markets, how many shareholders do you want, etc.”
Cal Evans believes that the crypto space is about to undergo huge changes, as the European Markets in Crypto-Assets (MiCA) may come into effect in 2024. Moreover, Dubai’s VARA regulations came into force in 2023, so the crypto scene will change significantly. The regulators in general are not typically trying to form a “better” relationship with crypto firms or those in the crypto industry. Their position is usually simple — “Make money. Pay taxes.” There are some locations that have special treatment for different digital assets, but these were usually rolled out as a package to attract more investors or innovative companies. Time will eventually show when these jurisdictions will come up with imposing new and probably stricter tax systems for digital assets.
