Cryptocurrency & Federal Income Taxes
We help people who are interested in minimizing their cryptocurrency tax liability while remaining in full compliance with Federal and state tax law.
For a free thirty-minute consultation, please feel free to make an appointment.
This page was first posted in October 2017, when BTC was around $6,000, and ETH $300. It was a simpler time.
It was last updated in November 2022, in the wake of the FTX scam. Most of our clients were experiencing various levels of hurt; some traders had enormous losses to report. These enormous losses, if realized and properly reported to IRS, can be used to offset their even more enormous gains in 2023 and future years!
As I write in mid-February 2024, BTC is hovering around $52,000. There is no legal way for a US citizen or permanent resident to escape cryptocurrency taxation, but good planning and good execution can keep your income tax liability to an absolute minimum while adhering to the Internal Revenue Code. But cryptocurrency law is emergent law.: a good-faith taxpayer and a good-faith IRS auditor may not always see eye-to-eye on the proper interpretation of the law. You need tax professionals who have wrestled with various crypto tax issues on many occasions.
Here's what we know now, based on the IRS's limited guidance on cryptocurrency. (This is an informal introduction.)
Notice 2014-21 Remains Our Primary Guidance
IRS first weighed in on the taxation of cryptocurrency ("virtual currency" in IRS-speak) with Notice 2014-21. Ten years is a long time….
Subsequent guidance focused on the taxation of hard forks (e.g., Rev. Rul. 2019-24 and subsequent guidance memoranda from the IRS Chief Counsel). Not too many people worry about the tax consequences of hard forks these days!
Is wrapping & unwrapping BTC and ETH a taxable event? Good question.
When is cryptocurrency farming and staking income subject to the Net Investment Income Tax? Another good question.
Are NFTs held for more than one year taxable at the 20% long-term capital gains rate, or the 28% collectible rate? Well, they’re generally not “tangible personal property,” but Treasury is always looking for moola…..
I have had the privilege of representing several clients in IRS audit examinations of cryptocurrency returns. I try to work collaboratively with IRS revenue agents on these difficult, unsettled issues while representing my client’s interests vigorously.
Mining is Ordinary Income and is Subject to Self-Employment Taxes
Per Notice 2014-21, the fair market value of cryptocurrency mined is business income on the date of its mining; the related ordinary and necessary business expenses (electricity and hosting, depreciation…) offset that business income. Bitcoin miners are subject to self-employment taxes, just as self-employed coal miners are.
If your "other" earned income is above the 2023 Social Security cap of $160,400, then you'll probably just be paying 2.9% to 3.8% in additional Medicare tax.
However, if your "other" earned income is substantially less than $160,400, be prepared for sticker shock on your tax return. Proper tax planning can mitigate the pain.
Gains and Losses on Cryptocurrency Trades
Again following Notice 2014-21, these gains and losses are similar in most respects to gains and losses on sales of securities.
As of now, you may be able to take advantage of a nice loophole: as of February 2024, the wash sale rules do not apply to crypto. There were serious proposals in the 117th Congress to close this loophole that ultimately stalled. To my knowledge, the issue has not been addressed in the 118th Congress, but don’t be surprised if the loophole is closed in the bipartisan tax bill that is expected to pass after the impending March 2024 government shutdown.
How to calculate basis on gains? LIFO (last-in, first-out) basis had obvious advantages in a rapidly appreciating market. Average cost basis will be easier to administer (no need to worry about "LIFO layers" ) and, in some cases, yield similar results. But average cost basis is rarely the optimal method. IRS and their third-party software partner have a strong preference for FIFO (first-in, first-out), and legislation has even been proposed to force taxpayers into using FIFO for crypto.
Transferring coins from one wallet you own to another wallet you own is not a trade. Of course, the basis of the transferred coins remains unchanged.
Accounting for these gains and losses is a major headache, especially if you are working with exported CSV files from multiple sources. There are good cloud-based software solutions. We work with several of these platforms on a regular basis.
And there are bad ones, too. We do our best to steer our clients away from substandard platforms.
We can help you choose the solution that fits your needs and your budget.
Foreign Income: General Painful Observation
Sorry, US citizens and permanent residents are subject to taxes on worldwide income.
If your income is sourced to the fictitious nation of Freedonia, you will generally be subject to Freedonian income taxes. (Whether your income is US-source or foreign-source may be determined by the US-Freedonian income tax treaty.) You will generally receive a credit for foreign taxes paid to Freedonia in the USA, to the extent that the US rate is higher than the Freedonian rate. But if you've paid 10% to Freedonia and your Federal marginal rate is 37%, then (speaking very roughly) you'll probably owe 27% to the Feds.
Again, sorry about that.
Don't forget to make foreign financial disclosures where required: pay particular attention to the requirements of FinCEN Form 114 and IRS Form 8938. For example, if one had an account in the equally fictitious "Son of Mt. Gox" (a good monster-movie title?), then one would normally be required to disclose that one holds an offshore financial interest in Japan. The level of disclosure would generally depend on the peak fair market value of your investment during the reporting year.
Puerto Rico as the Ultimate Crypto Tax Shelter
As Stephen Sondheim observed, “Nobody knows in America / Puerto Rico’s in America.”
Interested in Act 60? It’s not for everybody, but we do have clients down there….
In November 2022, I wrote, “Now is a great time to make this move! When BTC is above $50,000 again, it will be too late….”
Better late than never? I don’t take the hype on Reddit seriously, but even I will admit that BTC could break $150,000 in the near future.
See this page for a bit more information.
Death and Taxes (and More Pleasant Things)
Some crypto investors who have passed away in the past year have a taxable cryptocurrency estate ($12.92 million in 2023, increasing to $13.61 million in 2024). Even if the deceased's net worth was substantially less, the heirs might substantially benefit from filing an estate tax return to report stepped-up basis and dramatically reduce future capital gains. Even when a widow(er) inherits his or her spouse's estate tax-free, there still may be enormous benefits to filing an estate tax return for the deceased.
As we’re based in Chicago, I’d like to remind Illinois residents that the Illinois Estate Tax exclusion amount is a mere $4 million. Good planning is essential for Illinois residents. I am not an attorney, but I can work with your estate tax attorney to address cryptocurrency issues in estate tax planning.
Dying with too much crypto is no fun. Enjoy life: give some away to your loved ones! As of January 1, 2024, gifts in excess of $18,000 per giftee per year count against the gift-giver's lifetime exclusion. Are you contemplating giving or receiving a major gift of cryptocurrency? You may need to do some tax planning to maximize the effectiveness of the gift.
Again, I am not an estate tax attorney. Nor am I a CPA who specializes in estate tax or gift tax matters. But our firm routinely works in conjunction with specialists on gift and estate tax matters, including cryptocurrency matters. (Generally, we prepare these returns as the crypto tax specialists, and the estate tax specialist reviews our work product.)
Adversarial Dealings with the IRS
If you are an individual, partnership, or corporation doing battle with the IRS over crypto matters, please visit this page.
For a no-obligation thirty-minute consultation, please feel free to make an appointment.
Trading Crypto
Are you an arbitrage trader buying and selling on multiple exchanges all day long? You are my hero!
It would be a shame to pay taxes on the top marginal rate for the first eleven months of 2024, then get wiped out by the (hypothetical) Great Crypto Crash of December 2024. To add insult to injury, without proper planning, you would not be able to pair your losses against your income. If you qualify, a mark-to-market election under IRC Section 475(f) may make sense for you! (The window for individuals to make this election for beginning in a given tax year generally closes on April 15 of that year.)
The Highest and Best Use of Appreciated Assets
If you are charitably inclined and you have large unrealized gains, consider donating virtual currency to your place of worship or favorite 501(c)(3) nonprofit organization. (In the process, you may also become cryptocurrency evangelists: the pastor at Sleepy Smalltown Church and the executive director of your local cat shelter will need to open Coinbase accounts!)
Gift the cryptocurrency without selling! Let the charity worry about converting to US dollars, and you get the tax writeoff.
PLEASE DO NOT sell and gift the proceeds! The sale would be a taxable event, and the charitable benefit would be offset by the taxable gain.
You report your noncash charitable contributions on Form 8283; if you are gifting assets with a fair market value of more than $5,000, remind the charity that they need to provide Form 8282 to you.