At least once a week someone replies on Twitter or writes a comment on our YouTube channel asking whether you really need to worry about taxes when you’re receiving/trading digital currencies.
Lesson 1
You still have to pay taxes…really!
If you don’t want to go to jail….you should pay your taxes. Even though IRS regulations are evolving as it pertains to crypto, one thing that is clear is that any income received in crypto, must be reported on your tax return. They treat any selling or trading of crypto as capital gains and not reporting those gains is perjury - which is a crime. Don’t forget why Al Capone went to jail. Yes, taxes.
Lesson 2
How do they tax my crypto trades?
Generally, crypto trading is swapping one asset for another. This includes buying and selling coins, staking in liquidity pools, and flipping NFTs. These transactions are property-to-property exchanges subject to capital gains and loss treatment and, therefore, taxable.
In the case of NFT burns or burns to mints, the transactions are like a swap where you essentially trade one for the other. For example, if you had Ethereum (ETH) worth $1000, minting a JPEG and then sending it to a burn address will require you to write off that cost base as a loss.
In one way, you’ll have an excessive loss of $1000 but have a new token with a cost base of zero, plus the little gas used to mint it, and then you have an outsized capital gain. So, it’s in effect burning one to create another without having a substantial outsize loss.
Because it’s a rapidly evolving space, the IRS allows you to argue a position. The good thing about arguing your position is that you may avoid paying taxes for an event but note, in arguing a position you’re giving the IRS visibility into all of your crypto income/returns, which might trigger an audit.
Lesson 3
What if I’m paid in crypto?
Even though you’re paid in digital currency and not dollars, it’s still considered taxable income and reportable on a W-2. Some watch outs if you’re paid in crypto:
It’s possible to get double taxation when processing your capital gains
If you’re contributing to a DAO and being paid in a non-stable coin, consider organizing your employment vehicle as an S-Corp rather than C-Corp
Instead of remitting one hundred percent of your capital gains, you could send over 80% because the capital gains rates are more beneficial than the short-term rates.
Lesson 4
How can I minimize my tax burden?
Find good tax software with an algorithm to help determine your cost base. A great SaaS for this purpose is cointracker.io. Alternatively, look at different cost-based strategies and find one that works best.
Minimize tax evasion and maximize tax avoidance — Find strategies within the legal guidelines to pay the least taxes.
Actively work with tax professionals to restate balances and understand nuanced positions in crypto. Many Opolis Members work closely with Darien Advisors, a CPA firm expert in crypto taxes.
Target long-term investments that have lower tax rates compared to short-term investments. Long-term investments are held for more than one year.