Minimizing Tax Liability
Although there is no true way to “avoid” paying taxes on virtual currency, there are several methods that may reduce your tax liability. These include:
- Holding onto virtual currency long-term. Investors who hold their investments for a minimum of one year qualify for the long-term capital gains tax, which is highly preferential to the short-term gains tax rate you’d otherwise need to pay if you liquidated your virtual currency less than a year after obtaining it.
Depending on your tax bracket for the fiscal year, this simple method can reduce your capital gains tax rate by up to 40-50%.
- Offsetting gains with losses. Sell your virtual currency at a loss. This process, also known as “tax harvesting” involves selling your cryptocurrency or NFT for less than you paid for it.
Now you may be wondering: why would anyone willingly sell their capital assets at a loss? At times, selling at a loss can reduce your overall tax liability to a point where it would actually be of benefit compared to selling your assets at a profit and incurring further tax liability.
- Claiming data mining expenses. If you are a cryptocurrency miner, chances are you need a considerable amount of equipment to get the job done. Claiming expenses such as electricity, computers, servers, coolers, and other equipment can go a long way in reducing your taxable income.
Please keep in mind these deductions may ONLY be used if data mining is your profession – not your hobby.
Mining hosts often charge a “rent” or “use fee”. These fees can be used to offset your earnings.
Knowing your cost basis.
Your cost basis is the amount you spent to acquire the virtual currency, including fees, commissions, and other acquisition costs in U.S. dollars.
Your adjusted basis is your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars.
Timing transactions with your tax rates. Since capital gains taxes are assessed based on investor income, liquidating virtual currency when you have a lower income is a great way to reduce your tax rate.
The greater your income, the higher your capital gains tax rate. The lower your income, the lower your capital gains tax rate.
Donating virtual currency to charity.
And so, the question remains: can I do anything to avoid an audit? No. But there are things you can do to mitigate the damage that an audit can cause, including the following:
- Keep meticulous records of all your virtual currency transactions, including how much you paid or received and its FMV at the time of acquisition or disposition. Maintaining records doesn’t need to be a chore. It can be something as simple as an Excel spreadsheet or folder on your desktop.
Educate yourself on changing tax laws. Virtual currency is rapidly becoming a mainstream commodity. As evidenced by the IRS’ actions over the course of the last two years, there will likely be many changes in the future on how virtual currency is taxed.
By regularly scanning the IRS’ publications or routinely meeting with a tax attorney, you can stay ahead of the curb and report transactions before the IRS audits you.
Is Crypto Just a Fad?
Our world is ever changing and evolving, and our technology is great evidence of the fluid nature of our society. What had originally started as a fad has now become entrenched in our daily lives.
While Bitcoin could have disappeared without anyone being any the wiser, it has stuck around for over a decade and has proven itself to be firmly cemented in the here and now.
The cryptocurrency and NFTs that have come around because of Bitcoin’s success have likewise copied its foundations and become entrenched in human society.
As such, it is wise to continue educating yourself on this technology and applicable laws, for as technology continues to evolve, the laws that govern it do so as well.
Virtual currency audits have become one of the IRS’ top priorities. Virtual currency users are being audited at an unprecedented rate and the trend is likely to accelerate until the IRS can ensure tax compliance.
Virtual currency users must be diligent about reporting and assuming tax liability for their earnings.
Lastly, it is imperative that you remember that virtual currency transactions are no longer anonymous.
Given the IRS’ push for disclosure from third-party databases and the vigor with which they are pursuing Operation Hidden Treasure, the IRS will learn about your virtual currency transactions.
Therefore, it is in your best interest to properly report your earnings and file the appropriate tax forms.