Bitcoin and taxes: a guide to get started
In this article, we offer some thoughts and clarifications about the situation surrounding bitcoin taxes.
In 2017, Bitcoin proved its ability to spark great curiosity amongst society, make governments pay attention and create big gains for some, and losses for others. The great hype caused discussions on bitcoin and taxation to come to the forefront.
In this article, we discuss different approaches towards tax on cryptocurrency and how to best manage your crypto funds. Crypto taxation differs from country to country. As a result, we focus primarily on the unfolding bitcoin taxation frameworks in the EU and the U.S.
To help navigate this article, here are the sections that we cover:
- Contrasting approaches to crypto taxation
- Taxing cryptocurrency
- What about the EU?
- How to ease the stress?
Some members of the crypto community find the imposition of tax on bitcoin contradictory to its anonymous and decentralised nature. Others find it hard to comprehend the concept of tax on bitcoin. Why pay tax for anonymous earnings and transactions? Why pay tax within such an undefined regulatory environment?
In many countries, like the U.S. and in some EU Member States, cryptocurrency is subject to taxation. When crypto holders exchange or sell crypto assets, they will experience a capital gain or loss. Gains and income can be taxable even if they’re in the form of a cryptocurrency.
Just as the value of traditional fiat currency is deemed by the market’s invisible hand, bitcoin is also influenced by the value that’s attributed to it. As bitcoin continues to ease into the global economy and fluctuate along the way, a complicated process of tax reporting results.
Contrasting approaches to bitcoin taxation
As the price of bitcoin soared to all-time highs and demonstrated its ability to create massive gains, it became apparent for governments that cryptocurrency was a genuine asset that was growing in both popularity and use. As a result, some governments began to drive forward their coping strategies in a more intensive manner. Some executed “crypto crackdowns” that focussed on imposing extensive crypto and bitcoin taxes or the banning of crypto trading. Other countries agreed to build a more solid framework for regulating bitcoin tax.
The crypto/ bitcoin tax policies pursued within countries are guided by government-specific views of what cryptocurrency is used for, as well as its intrinsic value. Countries like Japan and Switzerland follow a more “crypto-friendly” approach. They are attempting to introduce regulation and reap the benefits associated with innovation based upon blockchain technology.
In February 2018, Switzerland released guidelines on Initial Coin Offerings (ICOs) which disclosed that in most cases ICOs will be treated as securities. The guidelines will enable “legitimate innovators to navigate the regulatory landscape”. Such regulations can create an environment for legitimate business innovation to flourish.
Overall, the European Union (EU) is far behind in terms of a crypto crackdown. In 2015, the EU Court of Justice ruled only on the relationship between value-added-tax (VAT) and bitcoin. Most EU Member States do not see the necessity of imposing new regulation while they wait for more EU guidance. As a result, administrative financial bodies within the Member States try to use existing national taxation frameworks to tackle crypto. However, that can also contribute to greater legal uncertainty.
In contrast, the U.S. already heavily taxes cryptocurrency within the context of a defined regulatory framework. According to the U.S. Internal Revenue Service (IRS), cryptocurrency should be treated as property. Hence, in the U.S., crypto is subject it to the same level of tax reporting as any other property type like stocks and bonds.
The IRS classifies bitcoin as a “convertible” cryptocurrency because while it can be traded online for other currencies, it can also be converted into fiat currency. In the U.S., the sale, exchange or use of bitcoin and other “convertible” cryptocurrencies to pay for goods and services are all regarded as taxable events.
Various other countries are also pursuing their own policies to limit the use of crypto. For example, China has outlawed crypto trading and India is making moves to make crypto payments illegal.
The process of accounting for bitcoin, and crypto, taxation can be overwhelming if unprepared. There are many elements to take into consideration; for example, types of transactions, transaction dates, fiat exchange rates, multiple wallets, and various exchanges.
Having to pay taxes can be triggered through trading, exchanging, spending, mining, conversion, air drops, ICOs and receiving payments in crypto. However, great diversity remains between the treatment of crypto transactions and their resulting tax within different legal systems.
However, as it is in the U.S., it can generally be expected that crypto transactions, which are subject to taxation must be reported in the fiat currency of the given country. Additionally, the exchange rate must correlate specifically to the exchange rate of the fiat currency on the given day of the transaction (sale, exchange, purchase). The base value of your coins can be derived from coinmarketcap.com or charts.bitcoin.com.
What about the EU?
The EU financial services commissioner, Valdis Dombrovskis has expressed with certitude that “blockchain technology holds strong promise for financial markets”.
“Transactions involving the purchase and sale of bitcoin are exempt from VAT because of bitcoin’s use as a means of payment”
For the most part, it seems as though the EU recognises the integration of cryptocurrency into the market as an unstoppable reality. Yet, the EU must find ways to alleviate its concerns about consumer protection, money laundering, and terrorist financing through the use of cryptocurrency.
Nevertheless, the legitimacy and long-term nature of the crypto sphere is recognized within the EU. The EU defines “virtual currencies” (including cryptocurrency) as “a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically”.
The Financial Action Task Force (FATF), an intergovernmental body based in France, draws attention to other crypto use cases including its role as “store-of-value products for savings or investment purposes, such as derivatives, commodities, and securities products”.
In 2015, the Court of Justice of the European Union (CJEU) found that although bitcoin is not considered as legal tender, it can be viewed as a means of exchange and used as a method of payment. The EU VAT (Value-Added-Tax) Directive stipulates that the supply of goods and services by someone in an EU Member State is subject to VAT.
However, transactions involving bitcoin trading are exempt from VAT because of bitcoin’s use as a means of payment. Such a supply of services for financial transactions does not fall under the scope of the VAT Directive.
In Germany, the Federal Ministry of Finance cleared up some questions regarding VAT and bitcoin. The Ministry confirmed the CJEU ruling that the exchange of bitcoin (and other payment only tokens) into fiat is exempt from VAT. They also stated that receiving bitcoin as payment does not trigger VAT because in that case, bitcoin simply serves as an alternative to fiat money.
The Ministry also asserted that Bitcoin mining is exempt from VAT. This is because it is not a traditional supply of services since there is no identifiable payment beneficiary. The tax exemption on mining is because the sum of transaction fees for a bitcoin payment is set voluntarily and cannot be directly linked to a specific mining service.
Nevertheless, Bitcoin miners still have to pay income tax and business tax on their gains from mining. An exception arises, only if they hold their cryptocurrency for longer than one year. In that case, any profit (or loss) is not taxable.
Furthermore, both the buying and selling of bitcoin and the use of bitcoin as a means of payment can be viewed as “sales”. These “sales” are considered as “speculative transactions” under German income tax. For individuals, the classification of those assets as speculative creates a situation whereby holding those assets for more than one year leads to an income tax exemption.
Tax reporting: good or bad?
Some EU institutions and Member States express high levels of concern about crypto activity and view cryptocurrency as an enabler in the conduct of illicit activity. Although, at the same time, they have not yet developed complete regulatory frameworks for crypto.
As of early 2018, Members of the European Parliament reached consensus with the European Council that wallet providers and exchanges should verify the identity of individuals using their services. Wallet providers and exchanges will be required to practice due diligence for customer identification in an attempt to curb illicit activity associated with virtual currency, including bitcoin. Although, Bitcoin users and companies are still waiting for new legislation.
In the meantime, research by the Center for Sanctions and Illicit Finance part of the Defense of Democracies Foundation found that between 2013-2016, only 0.61% of transactions on conversion services could be linked to illicit activity.
While bitcoin’s value skyrocketed to an all-time high of almost $20,000 in 2017 the price surge did not lead to an increase in reporting crypto activity to tax authorities.
In the U.S., on April 13th, 2018, it was found that only 0.04% of the 250,000 people who filed their tax reports (in advance of the April 17th deadline) on the Credit Karma Tax preparation software had reported crypto-assets. Likewise, in 2016, only 800 people had reported their crypto assets to the IRS.
The low levels of reporting may demonstrate a lack of clarity on the legal status of bitcoin, a potential resistance to tax on crypto activity and a clear difficulty in accounting for crypto transactions. That difficulty is amplified by the non-existence of simplified guidelines, alongside the stress that comes with accounting for all of the different exchange rates and the potential gains or losses on transactions.
With simplified official government guidelines, the process of actively recording transactions and deriving gains and losses would be easier to approach.
Instead, for some countries, like the U.S., the drive to correct perceived past failures will shine through and will extend to the retrieval of data on customers of exchange services to summon them to pay taxes for previous years.
Between 2013 and 2015, U.S. IRS criminal agents conducted an investigation into Coinbase Inc. (a leading cryptocurrency exchange) to retrieve the identity of its users and issue tax summons. Eventually, after a lengthy legal battle against the IRS, Coinbase was obliged to provide information on about 13,000 users with accounts that contained more than $20,000.
It is expected that the IRS will continue to investigate more crypto exchanges to uncover thousands of crypto users who have not reported to their crypto taxes. The U.S. crackdown is guided by a focus on curbing tax evasion, online drug dealing, and other illegal activities.
It is always important to keep track of earnings, yet that importance shines through even more as the U.S. crypto crackdown unfolds. It has been revealed that not only does the IRS require taxpayers to submit their crypto accounting for the last tax year, but their audits may also cover the previous three years. For some, that means quite a lot of accounting.
How to ease the stress?
We are already seeing a more manageable crypto accounting environment emerge. Many online tools that can help account for and manage crypto profits have been developed and are seeing widespread use. For example, LibraTax in the U.S. and Koyno in the EU.
Hodling your cryptocurrency for more than one year is generally regarded as an effective way to manage excess taxes. Patience may reward you with lower capital gains taxation. Converting one cryptocurrency to another after capital gains could be viewed as both a sale and a purchase by tax authorities. Thus, creating the likelihood of generating higher taxes than if the earnings were held in the fiat currency of a country.
The most important step to comply with tax regulations is to ensure that you keep records of all of your crypto transactions. We recommend that you keep track and trace your transactions to ensure compliance.
The use of various different wallet services may complicate the process of tracing transactions. But some wallet providers facilitate the easy retrieval of information on your transactions by offering the possibility to download a CSV file and export your data. Once you have downloaded your transactions you can begin accounting for gains and losses.
Moreover, software tools provided by platforms such as bitcoin.tax and cointracking.info, offer online solutions. Such platforms even present the possibility to directly import trade history, spendings, income, and mining income from various exchanges, as well as calculate capital gains.
It is still important to remember that you should hire a good accountant or tax lawyer if you are experiencing concerns about how to file reports on your crypto transactions or if you think that you may be liable to pay back sums of tax.
Experts individuals and empowering tools are becoming more prominent and growing in number to help with the incoming wave of taxation. As strict and complex rules and on taxation of cryptocurrency become more deeply embedded into legal systems, community members are beginning to tackle the unprecedented tide, to stay ahead, together.
While this guide has information on how to navigate bitcoin and taxation, it is not meant as tax or legal advice. We do not offer tax advice and highly recommend that you consult a taxation expert or accountant for guidance on how to file your crypto taxes.