Cryptocurrency—boy that’s a mouthful, let’s call it crypto for short—has become pretty commonplace these days.
No longer a taboo topic, more and more people are turning to crypto as an alternative currency. But because this is a newish option, the rules and regulations around using it as a business currency are still a little fuzzy. And as we all know, fuzzy and taxes really don’t go hand in hand. To clear up these muddy waters, and to help you avoid the awful surprise of an unexpected tax bill, here’s a basic primer on the taxation of crypto.
Crypto as (Taxable) Income
If your business receives crypto for services or products instead of cash, the value of the crypto (its market value when received) is taxable as ordinary business income.
Per usual, nothing is ever that simple in the world of income taxation. How crypto is reported on your tax return depends on your business entity type, so let’s break it down:
- If you do business as an individual, such crypto income should be reported on your Form 1040—aka your personal income tax return. It’s taxable at ordinary federal and state income tax rates—plus self-employment taxes.
- For owners of a partnership or an S-corp, remember that income gets passed-through to your Form 1040, so your share of the crypto income is taxable to you at ordinary federal and state income tax rates—plus self-employment taxes.
- As a C-corp, the crypto income is taxable—to your C-corp—at ordinary tax rates which are currently 21% plus possible state income taxation.
The point is this: if your business gets crypto instead of cash for your services or products, it’s taxable (at its market value when received) as if it were cash.
Crypto Capital Gains and Losses
The IRS generally treats crypto held by a business similar to stocks or mutual funds—as an investment asset. When you buy crypto, or when you receive it as business income, basis is created. The purpose of basis is to make sure you don’t pay tax on the same thing twice.
Here’s an example:
Let’s say you bought $100 of crypto then later sold it for $120. You got $120 of cash, but it’s assumed you’ve already paid taxes on the original $100, so that $100 is not taxable income. You sold it for $120 and the basis is $100, so $20 is taxed as a capital gain. If you had sold it for $90, you’d have a capital loss of $10.
Now, let’s say you provided services for a client worth $500 and were paid in crypto. The $500 would be taxable as ordinary income and the $500 would also be your basis in the crypto. If you later sold it for more than $500, you’d have a capital gain; if you sold it for less, a capital loss.
This is the basics of basis and how capital gains and losses are calculated. So how are capital gains taxed for your business entity type?
- For individuals, short-term capital gains are taxed as ordinary income. Long-term capital gains are usually taxed as special capital gain rates, currently 0%, 15% or 20%, depending upon your tax bracket (plus state taxation).
- For partnerships and S-corps, it’s the same as for individuals, since income passes through to your personal taxes.
- For C-corporations, capital gains are taxed at the corporate tax rates, currently 21% (plus state taxation). There are a set of rules that govern how different types of losses can offset different types of gain, but that’s outside of what we can cover here.
Read more about this from the ultimate experts in taxes, the IRS, here.Read more about this from the ultimate experts in taxes, the IRS, here.
When employees receive crypto as compensation, either for regular pay or bonuses, the value of the crypto on the day(s) paid must be reported on the employee's W-2. When paid, normal payroll taxes—federal, state, FICA and Medicare, etc—should be withheld. Since employees are not getting cash, this could get a little tricky. It’s workable but be sure to talk with your payroll provider or tax pro beforehand.
I hate to break it to you, but we’ve barely scratched the surface on this one. For one, if your business is as a broker or dealer of crypto, then capital gain and loss rules don’t apply. Also, paying an independent contractor with crypto is subject to the same 1099 filing requirements as paying with cash. There are many, many more examples of unique, interesting crypto taxation rules, so check out this article to learn more.
At the end of the day, here at inDinero, we know taxes and we’re here to help with your tax questions and conundrums. Get in touch with our tax experts today to help you take the cryptic out of crypto taxation.