Mastering Crypto Taxes: A U.S. Taxpayer’s In-Depth Guide

Cryptocurrencies have gained increasing acceptance and use across the world. Their decentralized nature and “enclosed” ecosystem initially made it difficult to integrate crypto transactions into the mainstream. Such complications led governments and responsible agencies to seek ways to ensure appropriate taxing of crypto transactions.

To date, most governments across the globe have yet to define definite taxation rules for transactions involving digital assets. For many of them, including the U.S., the digital assets tax framework is a work in progress. The responsible agencies continue to modify the rules as the industry evolves, due to the dynamic nature of the crypto industry, with more innovations appearing every day.

The IRS 2024 Update

The Internal Revenue Service (IRS) reminded U.S. taxpayers in January to answer a digital asset question and report all digital asset-related income when filing their 2023 federal income tax returns. In the updated tax report document, the IRS required users to indicate whether they received digital assets as a reward or payment for property or services, or if they sold, exchanged, or disposed of digital assets within the period under review.

Notably, the IRS’ reminder and update to the report document emphasized the dynamic nature of crypto taxation. For clarity, the tax agency further listed the various activities users need to check while ascertaining their crypto tax responsibilities. According to the IRS, taxpayers in the U.S. are liable for crypto tax if they:

• Received digital assets as payment for property or services provided;
• Received digital assets resulting from a reward or award;
• Received new digital assets resulting from mining, staking, and similar activities;
• Received digital assets resulting from a hard fork;
• Disposed of digital assets in exchange for property or services;
• Disposed of a digital asset in exchange or trade for another digital asset;
• Sold a digital asset; or
• Otherwise disposed of any other financial interest in a digital asset.

It is worth noting that cryptocurrency tax in the U.S. does not affect dormant digital assets or cryptos not involved in any form of business transactions. For instance, cryptos held in a wallet for the entire period, or those transferred between wallets controlled by the same individual or entity, are free from taxation. In addition, the IRS does not require tax payments on digital assets purchased using the U.S. dollar or other real currencies, including through electronic platforms. 

Having elaborated on the IRS requirement for cryptocurrency tax settlements in the U.S., let us delve into more details to help taxpayers in the U.S. understand how to calculate their tax responsibilities to avoid breaking the rules or making overpayments.

How is Crypto Taxed in the U.S.?

The IRS treats cryptocurrency similarly to stocks and other capital assets. That implies crypto assets are liable to varying tax rates. They could be taxed as capital gains or income, depending on how they are acquired and how long the users hold them. We’ve listed the kinds of crypto transactions liable to taxation in the previous section of this article. Meanwhile, it is also crucial to know that the IRS does not demand tax payments on digital assets if they are:

• Received as a gift until the recipient uses such a gift for transactions that can yield gains.
• Given as a gift. Here, there are limits to the amount that crypto users can gift others. As of 2024, the IRS would not require tax payments until the crypto gift’s value exceeds $17,000 for individuals and $24,000 for spouses.

Having noted the two categories of crypto taxation, as classified by the IRS, it is crucial to explain what they mean and how crypto users can determine their tax responsibilities. As previously mentioned, there are two ways in which the IRS taxes crypto users.

Capital Gains Tax

Crypto users in the U.S. are liable to capital gains tax when they sell their digital assets for cash worth more than what they paid to purchase them. Where such assets are sold at a loss, the users can deduct the losses from their taxes.

Users who convert digital assets from one form to another are also liable to capital gains tax payments. The logic behind this situation is that converting from one crypto to another involves selling the original asset for cash before acquiring the other. However, taxes only apply when you sell the original crypto assets for more than you paid to purchase them.

A third category of transactions requiring capital gains tax involves using crypto assets to pay for goods and services. The IRS considers spending crypto the same as selling it. Hence, the idea behind such transactions is that users need to sell the crypto assets before spending them.

Income Tax

This category of cryptocurrency tax by the IRS covers a broader sector of crypto activities, based on crypto users’ engagements. The various aspects of crypto transactions under the income tax category include:

• Getting paid in crypto: The IRS requires employees receiving payment in crypto to pay taxes according to their income tax bracket. 
• Crypto payments received as payment for goods and services fall under the income tax category. Hence, recipients are required to report such payments to the IRS for appropriate taxation.
• Users involved in crypto mining activities are required to pay income tax under the IRS regulations. The agency calculates the due taxes on coins received from mining exercises based on the fair value of such coins when the users receive them. For miners who mine crypto as a business, the IRS requires them to settle their tax responsibilities as self-employment income. The IRS adopts a similar model to earnings from staked digital assets. It bases the tax on staked coin rewards on their fair market value on the day users receive them.
• Holding certain cryptos, like the USD Coin, can lead to rewards. The IRS rules state that holders of such coins must pay income taxes on their earnings.
• Crypto users who earn crypto from hard forks are liable to income tax depending on how they use the asset and when the coins are available for withdrawal.
• Cryptocurrencies received during airdrops and marketing campaigns are subject to income tax. The IRS requires users to report the amount of assets they receive during such exercises.

Now that we have explained how crypto taxes work in the U.S., the IRS requirements, and the kinds of taxes the government demands from crypto users, it is essential to explain how users can keep records of their crypto transactions and how they can calculate applicable taxes on those transactions.

Keeping Records

The essential transaction records necessary for calculating and filing for crypto taxation include actual purchases, receipts, sale details, exchange, or any other disposition of the digital assets. Such details would enable proper calculations by determining the actual dates of the transactions to ensure fair market valuations of the crypto assets.

Maintaining sufficient records is a crucial requirement of the IRS, as it forms the basis of the position the agency takes on federal income tax returns.

Calculating Capital Gain or Loss

As a crypto user, it is essential to know how to calculate one’s tax requirements. To do so, there are a few details required. They include the type of digital assets involved in the transactions, the date and time of executing such transactions, the number of units of the digital assets, the fair market value of the transactions – measured in U.S. dollars, and the basis of the digital assets involved in the transactions.

With the above details and proper record-keeping, crypto users can independently study their transaction history over specified periods. That would enable them to determine their dues in tax requirements, helping them to ensure they are operating under the legal boundaries of their jurisdictions. Here, the U.S.

Meanwhile, it is worth noting that using digital assets for personal or investment purposes attracts a different tax requirement from using the same for business transactions. Personal use of digital assets means the IRS can only tax users when they sell or dispose of them. Under such conditions, the agency taxes the digital assets as capital gains or losses.

Receiving digital assets for goods and services during business transactions attracts a different kind of tax. The IRS, under such conditions, requires the crypto users to pay income tax as ordinary income or loss.

For personal or investment purposes, the IRS classifies cryptocurrency tax as short-term or long-term, depending on how long a user holds digital assets before selling or disposing of them. Assets held for one year or less before selling or disposing are considered short-term holdings, while those held for more than a year are regarded as long-term investments.

Like duration, determining the basis of a digital asset’s tax is also crucial and depends on the type of transaction. Users can extract this information by analyzing the type of digital assets in question, the date and time of acquisition, the number of acquired units, and the fair market value of the assets during acquisition.