Is not exactly visionary to say that crypto is the wave of the future. Crypto currency has already changed the financial world since the inception of Bitcoin BTC in 2009. Far from an esoteric digital asset, crypto currency has created a new world of decentralized finance. Other currencies are controlled by governments and their policies, which can, in turn, control the ebb and flow of a particular currency. The thing about centralized currency, is how closely governments can monitor it–mostly for tax purposes.
Crypto has gone mostly unregulated and, therefore, untaxed. However, that is likely going to change. The new infrastructure bill is going to add reporting requirements for crypto currency. This means that platforms where you can buy, sell, swap, and otherwise hold crypto (of which there are many) will be required to report transactions to the IRS.
What will the Tax Look Like?
Ever willing to put the cart before the horse, the government wants to institute these reporting requirements without giving clear guidance on how they intend to tax crypto. However, we can draw some conclusions based how other assets are taxed.
Capital Gains Tax
Crypto will likely be classified as a capital asset. Capital assets (like stock) are taxed when they are sold. The tax is calculated based on the price you paid and the price you sell it for (this is somewhat of an oversimplification but indulge me).
Therefore, if you buy $100 worth of ethereum ETH and it appreciates in value to where you now own $300 worth of ETH, you have a $200 gain. You may be taxed on that gain if it is “realized” i.e., when the asset is sold. If you hold the asset, and you don’t realize the gain, then you will not have capital gains tax (under the current tax laws).
Interest Income and Staking
It’s still possible to be taxed on the crypto that you are holding if that crypto is earning you interest. Those who own crypto currency can earn interest in a number of ways. Some platforms automatically give interest based on the level of assets you own. Other methods allow you to “stake” your crypto, essentially locking it up for a period of time to reduce volatility. Crypto owners can also “lend liquidity” to certain coins or crypto assets and earn interest by doing so.
This interest will likely be taxed as ordinary income like interest earned off of other capital assets.
Crypto currency is a novel thing but the taxes on it may not be so novel. What remains to be seen is how the government plans to enforce taxation of this “cryptic” asset. Stay tuned for more crypto tax developments to come.
Brenton S. Begley
Estate Planning & Elder Law Attorney