IRS Clarifies Tax Treatment of Cryptocurrencies: What You Need to Know

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The IRS issued rules around taxes that will simplify things for many cryptocurrency investors, although some questions remain.

In the past several years, cryptocurrencies have rapidly proliferated, gaining mind and market share among a digital-first generation looking for convenience, privacy, and autonomy.

Today, cryptocurrencies represent a comprehensive investment asset with diverse holding opportunities offered by niche startups and big banks alike. At the same time, consumers can use crypto to make purchases at Starbucks, Nordstrom, Whole Foods, and other prominent retailers. Even establishment tech companies like Facebook are getting in on the game.

But while innovation has been quickly accelerating, central governments have been struggling to keep up. Notably, cryptocurrency tax guidelines are notoriously outdated, as lawmakers try to cram new assets into antiquated regulations.

Despite promises to update the crypto tax code, no new guidance has been offered by the IRS since 2014, making last week’s release by the department especially noteworthy.

On Oct. 9, the IRS released a ruling and a frequently-asked-questions document that provides updated direction about the tax obligations for cryptocurrency users.

Here’s what you need to know.

Understanding the New Directives

In the past, all digital assets were taxed as property, a broad distinction that taxed all cryptos as a singular asset class, irrespective of use case or intent.

As many noted, this system failed to account for the specific use cases of today’s crypto assets, and it made many applications a logistical nightmare.

Now, there is a bit more nuance.

For example, rather than subjecting all investments to the same tax structure, investors holding digital assets for more than a year can avoid higher short-term capital gains rates. Based on these new guidelines, they can qualify for a 23.8% preferential tax rate.

Unfortunately, other crypto uses cases, like paying for services, continue to be taxed as capital gains events, something that still needs to be addressed in future rulings.

In addition, the ruling introduces a tax responsibility for coins attained through hard forks and airdrops. Hard forks, which are significant changes to a blockchain that produce a new blockchain ecosystem and, subsequently, a new digital currency, are now viewed with greater nuance as the token distribution that often follows a hard fork can occur in many different ways.

Similarly, users who received tokens through an airdrop will be assessed taxed based on the price at the actual time of receipt.

More specifically, the IRS now differentiates between hard forks that do not provide investors with new cryptocurrency and those that issue new, valuable tokens.

As the department explains, “If a hard fork is followed by an airdrop and you receive new cryptocurrency, you will have taxable income in the taxable year you receive the cryptocurrency.”

Moreover, the IRS equates hard fork token values with the “fair market value of the new cryptocurrency when it is received.”

Previously, the IRS did not differentiate between token acquisition methodologies. Buying cryptocurrencies on an exchange was treated in the same way as receiving them through an airdrop or in exchange for goods and services.

Ultimately, the new guidelines are intended to clarify crypto tax responsibilities by taking more of the guess-work out of the equation. As IRS Commissioner, Chuck Rettig, said in a recent statement, “We want to help taxpayers understand the reporting requirements as well as take steps to ensure fair enforcement of the tax laws for those who don’t follow the rules.”

Maximizing the Opportunity

Out of the box, many investors are worried about the long-term implications of the IRS guidelines. In July, the IRS sent letters to 10,000 crypto tax filers seeking amended returns for those that failed to report digital assets on their tax returns, and some fear that the letters and the latest guidelines could signal a broader crackdown on crypto taxes.

Even so, the IRS’s most recent guidelines do clarify some avenues for legally reducing crypto tax responsibilities, providing new opportunities for investors to minimize their tax burden.

In particular, the new tax guidelines favor long-term investments by allowing investors to take advantage of the lower long-term capital gains rate that maxes out at 23.8%, which could both cool the sometimes-erratic crypto price movements while also helping determine the trading strategy for many investors.

Similarly, crypto investors can view future platform movements such as hard forks and airdrops to account for the latest tax distinctions, meaning they can prioritize crypto companies that will expand and reshape with crypto taxes in mind.

Finally, the IRS noted that cryptocurrency received for performing services is considered self-employment income, meaning that the currency is subject to employment taxes such as Social Security and Medicare. The IRS explains, “the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.”

To be sure, this latest ruling is unlikely to be the last issuance from the IRS. Instead, the agency is counting on insights and direction from Congress before more fully regulating this burgeoning industry.

For those that have been waiting with bated breath for more information, this week’s news is a big deal. It’s also unlikely to be the only shoe to drop.

Read more at: https://www.thestreet.com/investing/bitcoin/irs-new-cryptocurrency-tax-guidelines-15123532

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