Welcome to a tax discussion of crytptocurrency! Below you will find a general discussion of tax principles, followed by my analysis of the current state of the law, followed by a handy tax calculator for those who wish to get a “back of the envelope” idea of what their taxes on crypto gains will be.
Please note that tax brackets change frequently! Do not hesitate to reach out with any comments.
There are two buckets into which we can put what we know about cryptocurrency tax law: items for which we have guidance and items that are still unknown.
Cypto Tax – What we know, What we don’t
We’ll start with bucket #1, what we know: The IRS was early to the table in defining virtual currencies as “property”, way back in 2014. As such, if you are a crypto trader or investor, your gain or loss on crypto trades will probably be capital gain. Capital gain, in turn, is taxed at your ordinary income tax rate, if it is short term (that is, you held the crypto for less than a year), or at a special long term capital gains tax rate (if held for more than one year). Which long term capital gains rate applies depends on your income, as shown in the following table:
Long-term capital gains tax rates for the 2021 tax year
Table 1
| FILING STATUS | 0% RATE | 15% RATE | 20% RATE |
|---|---|---|---|
| Single | Up to $40,400 | $40,401 – $445,850 | Over $445,850 |
| Married Filing Jointly | Up to $80,800 | $80,801 – $501,600 | Over $501,600 |
| Married Filing Separately | Up to $40,400 | $40,401 – $250,800 | Over $250,800 |
| Head of Household | Up to $54,100 | $54,101 – $473,750 | Over $473,750 |
So, the long term “base” capital gains rate will be 0%, 15% or 20%
In addition to this “base” capital gains rate, your capital gains can also be subject to the “Net Investment Income Tax” of 3.8%. Individual taxpayers are liable for the Net Investment Income Tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds the statutory threshold amount based on their filing status (shown below). In general, net investment income includes capital gains.
The statutory threshold amounts are:
Table 2
| Married Filing Jointly | $250,000, |
|---|---|
| Married Filing Separately | $125,000 |
| Single or Head of Household | $200,000 |
| Qualifying Widow(er) with a Child | $250,000 |
There are some wrinkles to calculating your holdings period. If, for example, you inherit a capital asset, you may be treated as having held it for more than one year if (a) the property’s basis in your hands is determined by reference to its fair market value on the date of the decedent’s death and (b) you sell or otherwise dispose of the property within one year after the decedent’s death. This rule applies regardless of how long the decedent owned the asset. If this rule doesn’t apply, the holding period of the property starts with the date of death.
So, that’s capital gains in a nutshell, but there are many other means of owning, holding, buying and selling crypto that are, or could be, considered “ordinary” income. Ordinary income is taxed at ordinary income tax rates according to a graduated schedule, as shown here for 2021:
Table 3
| 2021 Tax Brackets(Taxes Due April 2022 or October 2022 with an Extension) | ||||
|---|---|---|---|---|
| Source: IRS | ||||
| Tax Rate | Single | Head of Household | Married Filing Jointly or Qualifying Widow | Married Filing Separately |
| 10% | $0 to $9,950 | $0 to $14,200 | $0 to $19,900 | $0 to $9,950 |
| 12% | $9,951 to $40,525 | $14,201 to $54,200 | $19,901 to $81,050 | $9,951 to $40,525 |
| 22% | $40,526 to $86,375 | $54,201 to $86,350 | $81,051 to $172,750 | $40,526 to $86,375 |
| 24% | $86,376 to $164,925 | $86,351 to $164,900 | $172,751 to $329,850 | $86,376 to $164,925 |
| 32% | $164,926 to $209,425 | $164,901 to $209,400 | $329,851 to $418,850 | $164,926 to $209,425 |
| 35% | $209,426 to $523,600 | $209,401 to $523,600 | $418,851 to $628,300 | $209,426 to $314,150 |
| 37% | $523,600 or more | $523,600 or more | $628,300 or more | $314,151 or more |
These rates are referred to as “graduated” because there are different percentages of tax applied to different “tranches” of income. The higher your income (including short term capital gains) the higher the tax rate will be for each successive “tranche”.
Cryptocurrency taxation – What are the hot industry issues?
Which brings us to the question of when crypto income and/or gains would be taxed at ordinary income tax rates. As we know, there are many ways to make income in crypto, including through airdrops or forks, mining rewards, staking rewards, and reflection. The following table tells us what we know, and what we don’t, about the tax treatment of these different types of income:
| Income Type | Probably Treated As | When? | How Much? | Are You Sure? |
|---|---|---|---|---|
| Airdrops | Ordinary Income | Upon Receipt | Fair market value of coins received on date received | Yes |
| Forks | Ordinary Income | Upon Receipt | Fair market value of coins received on date received | Yes |
| Mining Rewards | Business Income (subject to offsets for ordinary and necessary business expenses) | Upon Receipt | Fair market value of coins received on date received | Yes |
| Staking Rewards | Either ordinary income (or self-constructed property) | Upon Receipt (upon sale or exchange of the property) | Fair market value of the coins received (Fair market value of the property sold) | No |
| Reflection | Ordinary Income | Upon Receipt | Fair market value of coins received on date received | No |
Whoa there, you may say, what’s with all the uncertainty? Well, that’s how it is for the moment, while we all wait for the powers that be, i.e. Congress and the IRS, to figure out how these matters will be taxed. Let’s take it a step at a time:
Airdrops and Forks – Pursuant to IRS guidance issued in Revenue Ruling 2019-24, cryptocurrency airdrops and forks are treated as ordinary income on the date the coins in question are received. This, however, leaves a few open questions. First, crypto is certainly volatile, so what happens if said cryptocurrency crashes the day after you receive it? Do you have income on the up day and are left holding the bag on the down day? The answer looks to be yes, unfortunately, which – through bad tax policy – could lead to some very unfair results as we have argued before.
Recipients of Bitcoin Cash, for example, which debuted at $578.58, were more than happy to get their manna from heaven, at least through the end of that year, when BCH hit $2,442.08. It wasn’t long, though, before BCH crashed in price, falling to $704.26 by March of 2018, all the way down to $116.86 in January, 2019. In other words, by the time taxes for 2018 were due bag holders were looking at considerably less in those bags than at the market peak, and those who were still into BCH in 2019 would have been at a net loss. Other cryptocurrencies were not as kind as BCH, as it was commonplace in those years for recipients to dump their forks right away, leading to large tax bills with little to show for it later.
Mining Rewards – Mining rewards, that is, true proof of work mining (not staking) are treated as ordinary income, however, this income may be subject to business-related deductions if you can say that you are in mining as a business. Note that what constitutes a “trade or business”, more specifically, is not limited to massive mining farms controlling thousands of Bitcoin miners. This can be in the form of a side-hustle, a handful of machines in your basement, what have you. Where the tax law draws the line between a “hobby” and a “business” is a fact-specific determination, and depends on whether your mining is regular and continuous. It also helps to show (both from a business and a legal standpoint) that the mining makes a profit. As with any business, record keeping and certain formalities are key, including:
- Whether you operate the business from an entity, rather than your personal name
- Whether the business has its own bank accounts, or crypto wallets, that separates that income from
- Whether you keep adequate records of your income (mining rewards), and your expenses (including hardware and electricity)
Keep in mind that keeping good records is a key consideration if you are ever in a position where you have to prove up your expenses. The basement part-timer may have a harder row to hoe in this regard, especially for expenditures such as electricity, which in a single structure could be for personal use as well. Consider opening – if possible – a separate account for mining-related electricity, if possible, and consider a separate structure for your machines.
Staking Rewards – At first blush, one might think that mining income and proof-of-stake staking income are the same animal. They are not. The key distinction is that running a proof of work miner does not require that you own any crypto at all, and, as noted, has expenses tied to the effort. Staking rewards, in contrast, is income derived from property you already own that has been alienated (staked) into an illiquid form for the purpose of securing a network. This may end up being a critical distinction in the tax law, although at present we don’t know for sure. One may argue, for example, that staking rewards are more like “self-constructed property” than dividends on stock. For example, a painter buys paint and a canvas. When he or she paints a painting for commercial purposes he or she realizes income upon the sale of that painting, not at some theoretical value the minute the painting is finished. In other words, the painter spends money to acquire tools to create something valuable from that property. So too might one view one’s coins as the paint used to create something of value, and, as such tax the gain at the time such property is sold, not when it is earned. The ongoing case of Jarrett v. USA considers just this issue.
Reflection – Reflection is a form of income that one receives simply by holding a coin that supports this mechanism. Put simply, reflection coins are those which were built with transaction fees built into their smart contract. Any time anyone buys or sells the coin a substantial percentage (sometimes 10-15%) of the amount spent is redirected (or “reflected”) to existing holders. The purpose of this feature is ostensibly to reward holders for continuing to hold, rather than moving into and out of the coin. Unlike staking, which requires some degree of sacrifice and risk on the part of the coin holder, reflected coins are received passively with no underlying risk to the coin the user is holding. In other words, subject to the “exit fee”, a user is able to freely sell their coins at their leisure. In this respect, the fees received by reflection coin holders is more akin to a dividend than their staked counterparts, and, as such, will probably eventually be treated as income upon receipt.Ari Good, JD LL.M. CAMS is a blockchain and cryptocurrency lawyer. The above considerations are for your information only. The crypto tax calculator is intended to give you only a general idea of your tax obligations. Contact your professional advisors for any further information, or call us for a consultation.
