The article is written by Jaideep Singh, CEO of AI-powered, SaaS platform FlyFin, Luke Olson, CPA, and Sridevi Yathirajyam, EA, FlyFin.
With 2021 winding down, this may also mean that the clock is ticking toward another upcoming tax deadline for many people in the USA. January 15th is when quarterly taxes are due if you’re self-employed (i.e., full-time day trader, freelancer, creator, or gig worker).
Any wise investor would know there’s no good hack to cheat the Taxman, and trying to do so may come back to bite you with nasty penalties. One area the government is even better at than taxing is applying penalties to taxpayers. There are, however, several sound steps you can take to shield your money and prevent the government from clawing back more of your hard-earned crypto gains.
Here are some tips to help you shield your crypto earnings from the Taxman.
1. What are the most important things to avoid getting audited for my crypto activities?
- Pay the taxes on time and file the tax returns within the due date.
- Pay your self-employment taxes on time, if applicable.
- Make sure to report all income from the forms of the copies issued to the Internal Revenue Service (IRS) like 1099-INT, 1099-DIV, 1099-NEC etc. Any unreported income may trigger an IRS audit notice. Do NOT assume that if your domestic or foreign crypto wallet did not generate a 1099, you can conveniently forgo disclosing gains. The IRS is getting data from various sources on crypto accounts.
- Report all the accounts on Foreign Account Reporting Forms – FBAR (Foreign Bank and Financial Accounts) and FATCA (Foreign Account Tax Compliance Act) if the yearly balance is above the threshold per the IRS. This is especially true if you have a non-US based crypto wallet.
2. What will the IRS be looking for to detect crypto tax cheats?
PSEs (Payment Settlement Entities) are required to send 1099-K to the account holder and a copy to the IRS if it has processed at least USD 20,000 worth of payments and at least 200 transactions during the tax year. Many PSEs send these Forms, though they have processed a few transactions and fall short of the USD 20,000 threshold. Form 1099-K tracks payments received through any PSE that includes credit card transactions, PayPal, and other online payment services, as well as freelancing platforms like Upwork, etc. Therefore, there is no chance to hide transactions from the IRS.
3. My brokerage or wallet/exchange did not generate any 1099s. Do I still have to report the gain?
You would receive the Form 1099 when you earned USD 600 or more in rewards or fees from Coinbase or other crypto exchanges during the year. Even if you do not qualify to receive Form 1099 for crypto gains, you’re required to report cryptocurrency taxes regardless of whether you receive any such forms. If you own a crypto-wallet it’s more than likely that the IRS knows about it, and a lack of transaction gain/loss reporting on your tax return could set off a red flag with them.
Self-Employed: If you are self-employed and your crypto activities are part of a trade or business, the information contained on Form 1099 will be reported on Schedule C.
Other than Self-Employed: For individuals who are not self-employed and file Form 1040, the virtual currency information will be reported as “Other income” on Schedule 1, Line 8 of the tax return.
4. What if my crypto wallet is not in the U.S.? Do I still have to pay taxes?
If you are a US citizen with investment income like capital gains, gains in virtual currency from sources outside the United States, you must report that income on your tax return as per US law. This requirement is applicable even if you reside inside or outside the United States and whether or not you receive a Form 1099 from the foreign payer. Aside from US citizens, anyone assessed to pay US taxes has to pay taxes on crypto gains; this includes Green Card holders, other residents and taxpayers.
5. What if I live abroad or am not a U.S. citizen?
Being a Non-U.S. citizen, if you have earned income from virtual currency from a U.S. source, you will need to pay tax on the amount of profit gained. Non-residents will pay tax at 30% on their income from cryptocurrency. And unlike residents, non-residents are not entitled to use losses from previous years to offset their tax liability.
If you earned your cryptocurrency profit from a different country, you will not only have a U.S. tax liability but may also have tax requirements in the country where the digital currency was bought and sold.
6. Can I have a relative who lives abroad open an account and not pay U.S. taxes?
Your relative who lives abroad, having the crypto accounts in their name, is liable for any taxes to be paid to the IRS. In any case, this would be tax fraud if you’re using a relative to invest your capital and then hide income.
7. If I buy and sell using a crypto-currency but leave my funds in a wallet untouched, do I have to report my gains?
As long as you are holding cryptocurrency as an investment and aren’t earning any income, you generally don’t owe taxes on cryptocurrency until you sell it. You can avoid taxes altogether by not selling any in a given tax year.
Taxable and nontaxable events include the following:
- selling cryptocurrency for fiat currency (i.e., USD, CAD, EUR, JPY, etc.);
- trading cryptocurrency for other cryptocurrencies (e.g., BTC for ETH, does not require cashing out to fiat to be taxable);
- using cryptocurrency to buy a good or service;
- receiving cryptocurrency because of a fork or from mining.
- buying cryptocurrency with fiat currency (except in cases where the purchase price is lower than the fair market value of the purchased coin);
- donating cryptocurrency to a tax-exempt organization;
- gifting cryptocurrency to anyone (if the gift is sufficiently large, it may trigger a gift tax);
- transferring cryptocurrency from one wallet that you own to another wallet that you own.
8. How can an individual taxpayer minimize the triggering of a taxable event?
For liquidity, despite selling appreciated crypto, you can borrow from collateral decentralized finance (DeFi) platforms which don’t trigger a taxable event.
9. How else can one avoid triggering taxable events around cryptocurrencies?
Trade crypto within a self-directed individual retirement account (IRA) so that all the gains and losses are sheltered in the account, and there will be no immediate tax consequences.
10. What other tips can individuals take to shield income from capital gains and other taxes related to crypto transactions?
- Holding an investment for more than a year usually allows traders to take advantage of lower long-term capital gains tax rates.
- Offset your crypto gains against capital losses, but the gains you offset can’t total more than your losses.
- Sell assets during a low-income year.
To help you meet the upcoming quarterly tax deadline, you can also check our new Crypto Tax Calculator.