In the past ten years, cryptocurrency — also referred to as ‘digital currency’ — has quickly risen up the ranks 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 then does tax cryptocurrency 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 to pay taxes on cryptocurrency?
How to pay taxes on cryptocurrency depends on if 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 a cryptocurrency tax software like CryptoTrader.Tax 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. CryptoTrader.Tax 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 (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 tax on crypto?
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?
How tax cryptocurrency works in Portugal
Portugal is a very crypto-friendly country. Crypto is exempt from VAT tax and personal income taxes in Portugal. However, businesses must pay taxes on any profits accrued from cryptocurrency gains.
Tax Residency: To become a Portuguese tax resident, you must either own a house in the country or stay in Portugal for more than 183 days. While EU citizens can freely move to Portugal, if you’re a US citizen, you must first obtain the right visa for legal residency. The best way to do this is to apply for Portugal’s Golden Visa Program. The good news is, several companies like Global Citizen Solutions handle the residency applications for the Portugal Golden Visa. To top it off, the company permits payment in cryptocurrencies like Bitcoin, Ripple and Etherium, with the payment being managed on the portal, Coingate.
Cryptocurrency tax-free countries: 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: 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 .
Crypto on taxes in Germany
German’s tax law dictates that any transaction amounting to €600 or less is exempt from crypto tax. Also, any gains from the sale of cryptocurrencies held for more than a year are also tax-free.
Crypto and taxes in Belarus
The government rolled out legislation in 2018 that exempts crypto tax on income derived from the mining, creation, buying, or selling of cryptocurrencies. Profits from the investing of crypto is also exempt from taxation. These tax incentives are in effect through to 1 January 2023.
Crypto and taxes in Switzerland
Regarded as Europe’s crypto haven, in Switzerland, individuals that buy, sell, or hold cryptocurrencies for personal use don’t need to worry about crypto on taxes. They are not required to pay tax on their capital gains. Nevertheless, income derived from mining (or self-employment income), is taxed through income tax.
How tax cryptocurrency works in Singapore
Since 1 January 2020, any exchange of digital payment tokens for fiat currency or other digital payment tokens are exempt from tax.
Important note: It’s important to acknowledge that any country can change legislation at any point in time. So just because you can enjoy tax incentives for crypto in let’s say Portugal, this might not be the case if the government alters the legislation in the future.
Frequently asked questions about tax cryptocurrency
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, 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.
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