Cryptocurrency, often referred to as digital or virtual currency, represents an electronic asset. It attracts not only investors and entrepreneurs but also the general public, as the value of cryptocurrencies has surged dramatically in recent months, compelling even those with minimal investment experience to engage with this innovative form of money. Supported by complex mathematical algorithms and computer software instead of traditional governmental or major financial institution backing, cryptocurrency remains minimally regulated. Although the opportunity to act as your own banking entity is enticing to many, one must be wary of the potential pitfalls associated with cryptocurrency, such as tax implications.

Given that cryptocurrency has been around for just ten years, regulatory bodies are yet to fully adapt to the nuances of taxing it. Initially, those who were quick to embrace crypto managed to dodge financial responsibilities regarding their assets. Nevertheless, for ordinary investors or buyers today, it's probable that your cryptocurrency investments will influence your tax responsibilities and filings.

Are you aware that your cryptocurrency might be subject to the same tax regulations as your regular income? Understanding the tax responsibilities associated with cryptocurrencies has become significantly crucial this year. It’s essential to determine if you are required to settle any taxes on them when submitting your tax return.

How is Cryptocurrency Taxed?

The digital essence of cryptocurrency makes it highly liquid. It facilitates simple transactions globally, yet only a handful of countries have started to regulate this emerging currency concerning taxation.

In the United States, digital currencies are treated as property in terms of taxation. This guideline has been in place following the issuance of a directive by the IRS in 2014. What implications does this classification have for those possessing cryptocurrencies? Below are several critical insights:

Individuals who conduct transactions using digital currency are required to disclose the specifics just as they would with traditional cash payments.

If you compensate your workers using cryptocurrency, it's necessary to deduct and declare taxes accordingly.

Tax regulations for self-employment apply to independent contractors, freelancers, and service providers who receive cryptocurrency as payment.

Profits and deductions resulting from the purchase or sale of cryptocurrency must be reported on your tax filings. This influences your tax declaration if the cryptocurrency qualifies as a capital asset (defined by IRS Publication 544 as an item you own or use for investment, personal, or recreational purposes).

Do You Need to Report Your Cryptocurrency?

The way in which you utilize cryptocurrency impacts what you can or cannot declare on your tax filings. For example, you may be exempt from disclosing capital gains on cryptocurrency used to finance your payroll, yet you are still required to compute and deduct standard income taxes.

Individuals who often face difficulties with the IRS are those who acquire significant quantities of cryptocurrency and subsequently dispose of it following an increase in its value. If you engage in such transactions and fail to accurately declare your earnings, you will face heightened oversight from regulatory bodies. The IRS is intensifying efforts to monitor those utilizing digital trading platforms to generate income by trading virtual currencies in a manner akin to conventional investment strategies.

Generally speaking, you will be subject to tax obligations if you:

• Exchange cryptocurrency for traditional fiat money, like Japanese Yen, U.K. Pounds, or U.S. Dollars
• Exchange one form of cryptocurrency for another
• Pay for services or goods.

Being as vigilant as possible is a wise strategy. As clearly indicated in official texts such as IRS Publication 544, the taxation guidelines for cryptocurrencies are not particularly simple. For example, while you can present cryptocurrency as a gift without incurring any taxes on your part, the fortunate receiver might face a gift tax if the value of the transfer exceeds a specified threshold.

How to Properly Document Your Cryptocurrency for Tax Returns

The unclear tax legislation might not be an issue for those holding cryptocurrency. Actually, there is an advantage to the property-status-dependent tax duties on cryptocurrencies: you do not realize any gains or losses until the cryptocurrency is sold. This particular point carries significant consequences, among them:

• You can hold some cryptocurrency for years before incurring a liability
• You should use the fair market value of the cryptocurrency you’re trading at the time of the trade to determine gains and losses
• Hold onto cryptocurrency for a year or more and you can pay long-term capital gains tax rates, which are significantly lower than their short-term alternatives.

Confused about classifying your gain as long- or short-term? In the realm of tax accounting, your asset's ownership period starts the day after its acquisition and concludes on the disposal date. Subsequently, you will need to handle the capital gains tax rates, which are dependent on your reported total taxable income. For tax returns filed in 2017, this implies that

• You’ll pay around 20 percent on long-term gains if you fall beyond the high-earner 39.6 percent maximum tax bracket
• You might pay nothing on long-term gains if your tax bracket is between 10 percent and 15 percent
• You’ll pay whatever your normal tax rate is if you claim short-term gains.

Should you have acquired digital currency through unique occurrences not typically associated with other investments, like Coinbase's dispersal of Bitcoin Cash in 2017, it is mandatory to declare this in your tax return for that particular year. The differentiation between two akin cryptocurrencies, Bitcoin and Bitcoin Cash, highlights the IRS's varying treatment of digital assets. Ultimately, it is essential that tax scenarios involving these virtual assets be managed individually.

Penalties You Could Face for Nonpayment

Ignoring your tax duties can be perilous. Per Publication 594, the IRS is empowered to impose penalties, garnish your earnings, or confiscate your property and assets. Additionally, they could pursue legal action against you for tax evasion, particularly if your earnings from virtual currency trading are substantial enough for the IRS to request your trading records from a prominent exchange.

In brief, ensure you settle your cryptocurrency taxes, and if you are uncertain about where to begin, consult with a specialist. Being proactive instead of reactive when it comes to taxes can avert potential financial hardships.