Do I Need To Pay Cryptocurrency Taxes?

When cryptocurrencies were new, early investors believed they could use them to gain value without government knowledge. However, government agencies like the Internal Revenue Service (IRS) soon realized that taxpayers could potentially use cryptocurrencies to avoid paying taxes. These agencies can now monitor and tax income from trading digital assets.

Learn how the IRS defines cryptocurrencies and how they are taxed below:

• Why are cryptocurrencies taxed?
• How cryptocurrency can risk tax evasion and fraud
• What cryptocurrencies does the IRS tax?
• How does the IRS tax cryptocurrencies?
• What crypto transactions are taxed?
• Taxes on cryptocurrency as an investment
• Do I need to report my cryptocurrency on my tax return?
• What if I didn’t buy or sell cryptocurrency?
• How does the IRS know about my cryptocurrency trades?

Why Are Cryptocurrencies Taxed?

Crypto assets are subject to taxes because they fit the IRS definition of property. Though cryptocurrency is a unique type of asset, many special property types are subject to taxes.

A cryptocurrency is a virtual currency stored in an encrypted format on decentralized networks using blockchain technology. These currencies are held in a digital wallet, like Coinbase. Unlike other currencies, cryptocurrencies are not issued by a government. Stablecoins are similar to cryptocurrencies but are generally tied to a more traditional fiat currency like the U.S. dollar.

Crypto assets are bought and sold on cryptocurrency exchanges. Online crypto exchanges may use either real-world currencies or other virtual currencies. For example, if you wanted to purchase Bitcoin, you could do so on an exchange with either U.S. currency or Ethereum virtual currency.

How Cryptocurrency Can Risk Tax Evasion and Fraud

Some crypto transactions are designed to be difficult for governments to track. This system creates conditions that raise concerns for financial crimes like scams, money laundering, international sanctions evasion, and tax violations. Consumers often become the victims of financial schemes when there is a lack of government oversight. Cryptocurrency has been viewed as the “Wild West” of the financial world, but the regulatory environment has been changing.

Crypto investors may assume decentralized trading will shield them against tax liability. But cryptocurrency doesn’t offer a legal loophole to avoid capital gains and income taxes. Hiding crypto income on a tax return is a form of tax evasion. This act is a crime with serious penalties. That’s why reporting crypto activity on your tax forms is important.

What Cryptocurrencies Does the IRS Tax?

The IRS taxes all digital assets traded in the United States, including popular types of cryptocurrency and stablecoins such as:

• Bitcoin (BTC)
• Ethereum (ETH)
• Tether (USDT)
• USD Coin (USDC)
• Binance Coin (BNB)
• Ripple (XRP)

People use "cryptocurrency" to describe a range of digital currencies. However, the IRS uses the term "virtual currency" for tax purposes.

According to the IRS, “virtual currency” describes the various types of digital currencies with an equivalent value in real currency and which can be used as a medium of exchange. These are convertible currencies, as they are easily converted into U.S. dollars or other real-world currencies. Commonly used cryptocurrencies are convertible digital currencies.

Taxes on Crypto Mining and Staking

The IRS may also find that you must pay taxes if you are involved in mining or staking cryptocurrency.

If you are engaged in cryptocurrency mining, the IRS will consider you to have earned taxable income. It may consider you to be self-employed and subject to the self-employment tax.

Staking is when you pledge your cryptocurrency to help validate blockchain transactions. In return for allowing the use of your currency, you will be paid a reward. The IRS treats this reward as income.

NFTs and Digital Assets

Cryptocurrency is not the only type of taxable digital asset. The IRS also taxes the profits you earn from the sale of nonfungible tokens (NFTs). NFTs are taxed as collectibles. This means they are subject to a higher capital gains tax than most other asset sales.

How Does the IRS Tax Cryptocurrencies?

The IRS does not have a designated "crypto tax." The agency treats cryptocurrency as property for tax purposes. That means the IRS applies the same general principles to taxing cryptocurrencies as it does to any other property you own. You are taxed on the profits from the sale of your cryptocurrencies.

How you are taxed depends on how long you owned it. If you sell cryptocurrency you owned for less than one year, the profits from its sale are short-term capital gains that receive the same tax treatment as ordinary income. However, if you hold the cryptocurrency for more than one year, it is considered a capital asset. It is subject to the long-term capital gains tax.

The advantage of treating the profits from the sale of cryptocurrency as a capital gain is that they will be taxed at a lower rate. The highest federal income tax rate for ordinary income is 37%, while the highest capital gains rate is only 20%.

What Crypto Transactions Are Taxed?

If you sell, trade, or use cryptocurrency to buy something, the IRS may find that you were involved in a taxable event.

Common cryptocurrency transactions include:

• Selling cryptocurrency for cash
• Trading one virtual currency for another
• Using cryptocurrency to pay for an item or service
• Receiving payment in cryptocurrency
• Cryptocurrency received in an airdrop
• Credit cards that offer cryptocurrency as a reward

Giving crypto assets as a gift is often nontaxable. However, the IRS has rules for what counts as a bona fide nontaxable gift. A high value of cryptocurrency may incur a gift tax. The IRS considers the value of a cryptocurrency gift in its fair market U.S. dollar equivalent.

When cryptocurrency is received as payment in return for work, as a reward, or through an airdrop, it is included in your gross income by the IRS and subject to the income tax. If you receive cryptocurrency in exchange for a financial interest in an asset, you will pay the capital gains tax on the difference between the value of the asset when it was acquired and the value that was received when you sold it.

Taxes on Cryptocurrency as an Investment

If you acquire cryptocurrency that you hold as an investment, you will not be taxed on the value of the cryptocurrency while you hold it. The taxable event occurs when you sell, trade, or exchange a cryptocurrency investment.

You will be subject to tax if the amount you realize from your cryptocurrency transaction is greater than what you gave up to acquire the currency (generally, the amount you paid). The initial value of the currency when you acquired it is known as your “cost basis" in the currency. This is usually the purchase price or the fair market value at the time it was received.

The difference between the cost basis and the selling price is your capital gain. If you sell for less than the amount paid, you may be able to take advantage of tax loss harvesting and claim a tax deduction for a capital loss.

Do I Need To Report My Cryptocurrency on My Tax Return?

Yes, you must report qualifying crypto activity when you file your taxes. The current Form 1040 individual income tax return asks filers whether they were involved in any virtual currency transactions. The taxpayer will mark “yes” or “no” as appropriate. Generally, if not reported as income, crypto activity is reported on Schedule D of Form 1040, which is used to report capital gains and losses.

What If I Didn’t Trade or Sell Cryptocurrency?

There is no tax on simply holding cryptocurrency, including if you transfer it between your digital wallets. There is also no tax on buying a digital asset with regular money at the fair market value. Yet, using cryptocurrency to buy goods or services typically incurs tax.

If your crypto assets gain value while you’re holding them during the year, you do not have to pay tax on the increase. Capital gains are only realized and taxable once you sell, trade, or otherwise dispose them.

Remember to review your records for the entire year to check for any reportable activity. For example, receiving cryptocurrency can be subject to tax. If you have questions about whether your cryptocurrency activity is taxable, get legal advice before filing your tax forms.

How Does the IRS Know About My Cryptocurrency Trades?

Crypto exchanges and brokers must report to the IRS each time a customer receives or disposes of cryptocurrencies. They must also keep certain information about users and transactions to reduce layers of anonymity from tax authorities.

While you may think the IRS doesn't know about your crypto activities, the agency has implemented new tax reporting requirements. For example, cryptocurrency vendors must prepare to issue a detailed IRS Form 1099-DA starting in the 2025 tax year. The IRS has sought court orders to compel vendors to comply with tax laws.

Tax regulations are still in flux, especially regarding decentralized finance (DeFi) and digital assets. Even if you believe there is a workaround to minimize or avoid taxes, you may want to discuss your liability with a tax lawyer. The IRS may investigate and discover unpaid taxes in the future — as it did in 2018 after a legal battle with Coinbase.

So, it's a good idea to answer the virtual currency question on your return honestly. This will help you avoid being penalized by the IRS when it discovers an unpaid tax liability.

Need Crypto Tax Help? Speak With a Lawyer

If you own cryptocurrencies or are considering conducting financial transactions with them, you may want to speak to a local tax attorney about possible tax implications. The tax consequences of engaging in crypto transactions can be complex, and the tax rules are constantly changing. A tax professional can ensure that you comply with all tax laws and represent you if the IRS has questions about your income from cryptocurrency transactions.