In the past ten years, cryptocurrency—also referred to as ‘digital currency’—has quickly risen to become a globally respected virtual currency. The cryptocurrency market continues to grow exponentially, showing no signs of slowing down just yet.
Transactions are quick, digital, secure, and worldwide, which means record-keeping is done without the risk of data being pirated. Nowadays crypto can be used to pay for goods or services, to invest in, or even exchange funds with someone else.
So how does crypto tax work? In this ultimate guide, we walk you through the mechanics of tax cryptocurrency and how to stay on top of your finances as a US tax-paying citizen.
What Is Cryptocurrency?
Cryptocurrency is a digital currency. You can’t see it or touch it, but it’s there. While cryptocurrency units are named ‘coins’, they’re not a physical coin. You keep crypto coins in a digital wallet or use an exchange or brokerage. While various cryptocurrencies exist, the two most popular ones are Bitcoin and Ether.
Instead of using a bank to create, transfer, and exchange funds, crypto uses an encrypted blockchain network to process transactions. The best part about crypto is that no bank or government controls it like with traditional currencies. Rather, crypto works through blockchain — it’s practically a digital database (distributed public ledger) — and is run through cryptography.
What makes cryptocurrency like Bitcoin so secure is that it’s digitally confirmed by a process known as ‘mining’. What this means is, all the information that enters the Bitcoin blockchain is mathematically checked using a complex digital code set up on the network. That blockchain network will confirm and verify all new entries into the ledger, as well as alterations.
Are cryptocurrencies taxed?
Since 2014, the IRS considers crypto as property. As such, bitcoin and other cryptocurrencies should be treated as property for tax purposes, not as currency. So crypto must be treated like owning other property like stocks, gold, or real estate. You must report your capital gains and losses from your crypto trades on your taxes.
If you don’t do this, you might be committing tax fraud. Crypto users must report transactions as US dollars on their tax returns, which means they must establish its fair market value as of the transaction date. To determine the fair market value, you just need to convert the virtual currency into US dollars or into another currency that is then converted into US dollars.
How Do You Pay Taxes On Cryptocurrency?
How to pay taxes on cryptocurrency depends on whether you’re holding coins or crypto-assets (referred to as tokens). If you receive coins for goods or services rendered, then it’s a straightforward process. It basically counts as an ordinary income and falls into the category for taxes.
If you happened to pay someone with bitcoins or another currency, you must figure out exactly when you acquired or bought those coins. If it was under a year ago, any change in value falls under the ‘ordinary’ income bracket. If it was more than a year ago, then according to the IRS, it’s the same thing as cashing out a long-term profit or loss. This then gets taxed as capital gains.
To avoid any tax mishaps, it’s recommended to keep track of your transactions through an app or software just for this very purpose. For example, CoinTracker is an excellent tool to keep track of your gains and losses, as well as a good record-keeping tool for tax purposes.
You can also use cryptocurrency tax software to handle your tax reporting. To use the software, just select each exchange you’ve used and import your history of transactions from that exchange. The software automatically generates your crypto tax forms based on the data supplied.
You are required to keep track of the following:
- Purchases or dates you received your crypto
- Dates when you sold or spent it
- Amounts of the transaction
The general rule of thumb is, gains or losses accumulated in periods of less than 12 months are considered other income when the time comes to file your taxes. Anything accrued over a year is ‘capital gains or losses’ on your tax form.
Follow these five steps to file your cryptocurrency taxes:
- Calculate your gains and losses
- Complete the IRS Form 8949 (the form is used for reporting the sales and disposals of capital assets)
- Include your totals from 8949 on Form Schedule D (take your total net gain or net loss from 8949 and add it in Schedule D)
- Include any crypto income on Schedule 1 (or Schedule C if you are engaging in crypto taxes as self-employed)
- Complete the rest of your tax return
What Are The Tax Rules For Cryptocurrency?
The tax rules for cryptocurrency are straightforward. If you use crypto like Bitcoin as an actual currency, it’s considered a taxable event. If a business owner accepts crypto as a payment option, as well as for the individuals who choose it as an actual currency rather than an investment, then each transaction — no matter how big or small — must be reported on annual taxes.
IRS introduced a new form 1040 inviting taxpayers to say whether they own any virtual currencies or not.
How Do You Avoid Crypto Tax?
All US citizens must pay tax on their capital gains and cryptocurrency is no exception. No matter where you live, you must pay US tax on your trading profits. Failure to do so can result in a huge fine and even a prison sentence. So is it legally possible to dodge tax and if yes, how do you avoid tax on crypto?
You can give up your US citizenship to avoid tax on crypto. To do this, you typically need to pay an ‘exit tax fee’ and have a second passport on standby. Without a second passport, you can’t expatriate from the United States.
Is it worth it to renounce your citizenship to avoid tax on crypto?
The United States has a worldwide tax policy. Simply moving abroad but keeping your US citizenship isn’t enough to avoid getting taxed. So, if you don’t believe in getting taxed on your bitcoin or other cryptocurrency, then you can absolutely renounce your citizenship.
The good news is, there are a number of crypto-friendly countries that won’t tax you on certain cryptocurrency gains. Some countries won’t tax you on any gains! And the even better news is, it’s relatively easy to apply for a second passport abroad or seek second residency. You can do this through citizenship by investment or a residency by investment program.
Crypto taxation & dual citizenship
The way crypto taxation and dual citizenship works is, you can apply for citizenship in another country, grab your passport then renounce your US citizenship. The best way to do this is through citizenship by investment — an initiative that welcomes investors to invest in the country in exchange for citizenship.
The most crypto-friendly countries that run citizenship by investment programs include:
- Malta Citizenship by Naturalization for Exceptional Services (qualifying investment starts from €690,000)
- Dominica citizenship by investment (qualifying investment starts from $100K)
- St. Lucia citizenship by investment (qualifying investment starts from $100K)
It’s also possible to earn a passport through residency by investment. For example, the esteemed Portugal Golden Visa program welcomes investors to invest from €280K, and in turn, they’re rewarded with legal residency. After six years, you can apply for a Portuguese passport.
What are the cryptocurrency tax-free countries?
The cryptocurrency tax-free countries are basically crypto-friendly countries that have gone out of their way to attract cryptocurrency traders to their shores. In other words, where is Bitcoin not taxed?
Portugal
Portugal has long been at the forefront of crypto-friendliness. The country became a hub for trading and mining crypto in the early days of blockchain development.
In 2017, the government implemented several pro-crypto policies. These included favorable tax treatment for crypto trades and investments. Additionally, the country has established a strong infrastructure to support blockchain startups.
This was further reinforced by the introduction of the Portugal D7 Visa program, allowing individual investors and other professionals involved in the industry to live in Portugal without any immigration restrictions.
Portugal has been recognized as one of the best crypto tax-free countries in Europe. All crypto activities have historically been exempt from both capital gains and income tax. Transactions made with cryptocurrencies were also not subject to taxes.
However, due to the increasing cryptocurrency activity, Portugal has decided to begin taxing short-term gains on crypto in 2023. Profits made on crypto holdings or any other digital assets held for less than one year are now taxed at a rate of 28 percent. Authorities also treat gains from the issuance of cryptocurrencies and mining operations as income, which are, therefore, subject to income tax.
Some believe that this weakens Portugal’s status as one of the few cryptocurrency tax haven countries. However, it still remains a favorable environment for crypto investment, especially with tax-free measures for individual investors planning to hold crypto long-term.
Portugal’s crypto-friendliness also extends to real estate investments, as it is one of the first countries to allow investors to buy property in Portugal with crypto through a streamlined initiative created by the Order of Notaries (ON).
Take a look at our Portugal Crypto Tax and Cryptocurrency Ultima Guide
Malta
Malta is pro-bitcoin, and in 2018 established a legal framework for blockchain technology. It welcomes blockchain technology and cryptocurrency companies with open arms and has a number of incentives in place to attract investors.
While Malta does not tax long-held digital currencies either for capital gains or VAT, crypto trades executed within the day are treated similarly to day trading in stocks and foreign exchange. This means that you do have to pay some tax as business income, typically at 35%.
Tax residency is determined by whether you are considered an EU/Swiss/EEA citizen or not. If you aren’t, you need to pursue residency first in Malta in order to enjoy the tax-free privileges for your crypto. The best way to do this is to apply to the Maltese Granting of Citizenship for Exceptional Services .
Germany
Germany is often thought of as a bastion of financial stability, with its highly-rated banks establishing its reputation as a safe haven for investors.
The country has a long history of being a reliable investment destination, and its strong economy and political stability make it an attractive option for those looking to park their money in a safe place.
However, Germany is also an attractive option for crypto investors for another reason: Its crypto tax laws are similar to Portugal’s tax system in that crypto assets held for more than a year are not subject to capital gains tax.
This means that long-term holders of cryptocurrencies can realize significant gains without the burden of taxation, encouraging investment and holding behavior rather than short-term speculation.
Moreover, Germany recognizes cryptocurrencies as private money. This classification comes with specific tax implications. For instance, if cryptocurrencies are sold within a year of purchase and the total gains exceed 600 euros, the profits are subject to progressive income tax rates, which can range from 0% to 45%.
However, if the sale results in a profit of less than 600 euros, it is tax-exempt. This approach incentivizes investors to consider the timing of their transactions carefully.
Belarus
Belarus has created a favorable environment for cryptocurrency by offering significant tax exemptions to encourage both businesses and individuals to engage in cryptocurrency activities.
These tax exemptions were implemented as part of a broader strategy to position Belarus as a hub for IT and blockchain technology.
The aim is to attract international businesses and investors to the country. This approach by Belarus reflects a progressive stance towards cryptocurrency, encouraging its adoption and integration into the national economy while providing significant financial incentives for participants in the cryptocurrency market.
Both individuals and businesses are exempt from capital gains tax on income derived from cryptocurrency transactions. This exemption is designed to stimulate investment and trading within the country, making it an attractive destination for crypto enthusiasts and investors.
Additionally, income earned from mining, buying, and selling cryptocurrencies is exempt from personal income tax for individuals. Similarly, businesses engaged in cryptocurrency activities, such as trading, mining, and offering ICOs (Initial Coin Offerings), do not pay corporate income tax on their earnings.
Switzerland
The home of Crypto Valley, the largest blockchain and distributed ledger ecosystem in the world, Switzerland is a renowned financial center and home to numerous globally recognized banks.
Switzerland is considered one of the most attractive countries for cryptocurrency investors due to its favorable regulatory environment and abundant opportunities for tax minimization.
The federal tax system in Switzerland operates at the cantonal level, allowing for a degree of customization. With 26 cantons in the country, each has its own tax laws, although some general principles apply throughout.
For instance, at the federal level, capital gains from cryptocurrency investments are tax-free, giving cantons the flexibility to establish their own tax policies regarding crypto assets. In most cases, the tax rate on capital gains from crypto is lower than that on other forms of income.
Additionally, Switzerland offers various special tax regimes to reduce taxes on crypto transactions and investments. For example, the “Qualified Investor” regime exempts certain types of income from taxation. Other regimes provide for reduced taxation on capital gains or dividends.
It’s important to note that Switzerland does impose a wealth tax on worldwide assets, but the tax liability on crypto investments is determined by the wealth tax rate and threshold, as well as any other tax relief benefits for which investors are eligible.
Singapore
Singapore is a country that epitomizes structure and financial stability. The country’s strong economic growth, pro-business environment, and low taxes have made it an attractive destination for both individuals and businesses.
In recent years, Singapore has become one of the number one cryptocurrency tax haven countries, with a favorable tax regime, lack of capital controls, and developed financial infrastructure, making it an ideal place to invest in digital currencies.
It’s no wonder why large crypto exchanges like KuCoin and Phemex are based in Singapore. The country imposes no Capital Gains Tax on crypto owned by investors or businesses.
Additionally, cryptocurrencies are viewed as intangible property in Singapore. From a tax perspective, when crypto is spent on goods and services, this is viewed as a barter trade (the act of trading without the use of money), not a payment.
So, while the goods or services may be liable for Goods and Services Tax (GST), the payment coin or token will not.
Frequently Asked Questions About Cryptocurrency Taxes
Where is Bitcoin not taxed?
Bitcoin is not taxed in the following countries (with some exceptions of course): Malta, Portugal, Belarus, Switzerland, Germany, Georgia, Singapore.
What is tax on cryptocurrency?
Tax on cryptocurrency in the United States basically means declaring your tax derived from the capital gains and losses of your crypto transactions.
This is because the IRS treats crypto as property for tax purposes. Just like other types of property then (stocks, bonds, real estate) you must report your tax at the end of the financial year.
How do crypto tax avoidance and dual citizenship work together?
Crypto tax avoidance works by applying for dual citizenship in another country.
Once you acquire a second passport through an initiative like citizenship by investment, you can then renounce your US citizenship. Like this, it’s possible to avoid certain taxes on your cryptocurrency.
Malta, for example, offers passports to qualifying investors. You must first make an investment and then get the passport in one of the world’s most crypto-friendly countries.
How to keep track of my tax cryptocurrency?
You must do some accurate bookkeeping if you’re planning to use crypto. There are several accounting solutions for this like QuickBooks.
Start keeping records from the start, since digging through years of past transactions could be extremely difficult.
Are cryptocurrencies taxed?
Yes, all cryptocurrencies are taxed in some form or manner, depending on the nature of your transaction.
What countries are considered crypto-friendly?
Some of the most crypto-friendly countries include Portugal, Malta, Cyprus, the US, and Australia.
