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How to legally avoid crypto taxes

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As a new type of asset, cryptocurrency has generated enormous riches for its earliest adopters. When new wealth is created, however, it is often subject to taxation.

Because of the wild price swings of cryptocurrencies like Bitcoin and Ethereum, investors in these markets may be left with some pressing tax concerns. Many people think cryptocurrencies are a wonderful investment, but they need to factor in the possibility of paying taxes on their profits.

In 2021, more than 10% of all Americans traded in cryptocurrencies. If you fall into this category, you’ve probably wondered how the IRS views your cryptocurrency trading and other related activities.

The IRS is increasing its enforcement operations, so anyone with currency in their possession, let alone those who deal in it, should be careful not to break the law. Considering the IRS’s stance on cryptocurrencies, this may be easier than you think.

All crypto transactions, conversions, payouts, and income must be reported to the IRS and, if applicable, state tax authorities in the United States.

Insights into the taxation of cryptocurrencies

In the United States, cryptocurrency is categorized as a digital asset and is taxed similarly to stocks, bonds, and certain capital assets. Gains from cryptocurrency are taxed in the same way as those from other assets: as income or capital gains, depending on how the cryptocurrency was acquired and for how long it was kept.

Capital gains are subject to taxation; however, the rate and kind of tax owed will vary. Capital gains can be either short-term (earned in a short period) or long-term (earned over a longer period), depending on how long the asset was held. In this example, the asset is cryptocurrency.

Capital gains: short-term – Profits from trading digital currencies arise when investors sell cryptocurrencies for more than they paid and hold them within a year. As a result, it creates a taxable event that must be taxed at the same rate as the taxpayer’s wage income.

Capital gains: long-term – Gains are realized when investors sell cryptocurrencies for more than they paid, provided that they have held the investment for more than a year. Long-term capital gains are taxed at generally lower rates, sometimes reaching zero.

Examining how you spent your cryptocurrency in the prior year will help you determine if you have any tax obligations associated with it. “Taxable events” are those that cause a tax. The ones that don’t are referred to as “non-taxable events.” Let’s examine each of these in turn:

Taxable events: income

●       Mining crypto: If you mined cryptocurrency and received coins as payment, you may be required to pay taxes on those earnings at the time. When receiving these taxes, they would be calculated using the coins’ fair market value (typically their price). Income from cryptocurrency mining done as a business is treated as self-employment income.

●       Receiving cryptocurrency payment: If you requested payment in cryptocurrency, your employer must treat the funds as remuneration and tax them accordingly.

●       Accepting cryptocurrency as payment for services or commodities: You must disclose cryptocurrency earnings to the IRS if you accept it as payment for goods or services.

●       Obtaining cryptocurrency via a hard fork: How you use the cryptocurrency you received following a hard fork when it becomes withdrawable from your exchange (including other factors) affects the amount of taxes you will owe. Please refer to the Internal Revenue Service’s most recent hard fork instructions for more information.

●       The process of receiving an airdrop: During a promotional period, a cryptocurrency company may send you airdrops as a form of free token distribution. Any money you get from an airdrop must be reported as income.

●       Obtaining the staking rewards: Like mining profits, the day you collect your staking payment is the day your taxes are calculated using the amount’s fair market value.

●       Getting paid in other ways: Keeping some cryptocurrency in your portfolio could be profitable. That sum must be reported as income on your tax return. It’s not the same as interest from a bank, but it’s still considered income by the Internal Revenue Service.

●       Getting some other kind of reward or incentive: The possibilities for getting free cryptocurrency extend far beyond those listed here. Some examples of such incentives include receiving $5 in bitcoin for introducing a person to a cryptocurrency exchange or bonuses from learning reward programs. In any case, you must include these amounts in your tally of earnings.

Taxable events: capital gain

●       Buying things with cryptocurrency: Bitcoin taco purchases, for example, could result in tax liability. Investing in cryptocurrency is similar to selling it in the eyes of the Internal Revenue Service. In order to trade an asset for a product or service, the asset must first be sold. When it is sold, any capital gains it has made are taxed.

●       Changing from one cryptocurrency to another: Here is an example: if you want to buy XRP using Binance coins, you must first sell some Binance coins on the market. The transaction is viewed as taxable by the IRS as it represents a sale. If you made a profit from selling your bitcoin, you must pay taxes on that amount.

●       Selling cryptocurrency for cash: You must have exchanged your cryptocurrency for money, right? If you make a profit when selling an asset, you must pay taxes on the gain. If you sell something and take a loss on the transaction, you might be eligible to deduct the loss from your taxes.

Non-taxable events

●       Funding your wallet using cryptocurrency: You won’t have to pay taxes when you move cryptocurrency from one wallet or account to another. You can choose to keep your initial cost basis and the date you bought the property so that you can keep track of the possible tax effects of your sale when it finally happens.

●       The practice of purchasing and keeping cryptocurrency with cash: Simply purchasing or possessing cryptocurrencies does not in and of itself result in taxable income. Most of the time, you have to pay the tax after the fact, when you sell the asset and make a profit.

●       Offering a gift: You are exempt from paying taxes on gifts of up to $15,000 given to each recipient annually. What’s more interesting is that you can give more than that to your spouse. If the value of your gift to each recipient is more than $15,000, you are required to submit a tax return. This doesn’t usually translate into any of your current tax liabilities. However, if you send cryptocurrency to someone other than in exchange for products or services, it could be considered a gift, even if that wasn’t your intention.

●       Receiving a gift: If you are fortunate enough to get cryptocurrency as a gift, you will not likely be taxed on it until you sell it or engage in another taxable activity, such as staking.

How to legally avoid crypto taxes

You must pay cryptocurrency taxes if you live in the United States and own crypto. As cryptocurrency is typically held by individuals as an investment, it is subject to the capital gains tax regulations in the USA.

It’s important to remember that cryptocurrencies are still in their infancy, and tax policies regarding crypto assets may change in the future, either by the Internal Revenue Service or Congress. But here are a few ways to reduce or even get rid of the taxes you have to pay on cryptocurrency transactions under the current tax system.

  1. Keep your cryptocurrency holdings for the long haul

Until you sell your cryptocurrency, you normally won’t have to pay taxes if you just hold it as an investment. To avoid paying taxes, you must avoid selling any within any given tax year.

It’s possible, though, that you’ll want to unload some of your crypto holdings at some point. If you want to pay less in taxes while selling cryptocurrency, you should wait at least a year. If it has, then the profits from the sale of your cryptocurrency may be subject to the more lenient tax rates for long-term capital gains. This will likely reduce your tax liability significantly.

  1. Invest in cryptocurrencies using an IRA

Cryptocurrency can be purchased tax-free in a self-directed IRA, though this is only the case for some retirement plans. Stocks, mutual funds, and exchange-traded funds are mainstream assets acceptable in most IRAs (ETFs). You can invest in If you have a self-directed IRA, you can use it to invest in gold, real estate, and digital currencies.

Your tax benefits after opening an IRA account depend on your tax situation and the kind of IRA you select.

Contributions to a traditional IRA may be tax deductible, but withdrawals during retirement are subject to ordinary income tax rates. If you qualify, your withdrawals from a Roth IRA in retirement will be completely tax-free, but you’ll have to deposit after-tax dollars into the account.

  1. Sell assets in a low-income year

The tax rate you pay on your capital gains, whether short-term or long-term, is based on how much money you make. The tax rate declines as taxable income decreases. Tax savings could be made by selling cryptocurrency, whose value is expected to rise in the next tax year when the taxpayer will pay less in taxes.

Even though some money from selling cryptocurrencies may be taxed at a higher rate, this does not, contrary to popular belief, put you in a higher tax bracket.

  1. Treat your loved ones to a crypto gift

If you’re looking to minimize your taxable cryptocurrency profits, consider making some gifts. Neither the giver nor the receiver will be responsible for any gift taxes. As it stands, annual gifts of up to $15,000 to any one recipient are exempt from both gift tax returns and gift tax payments. If you give more than $15,000 to a single recipient in a given year, you will be exempt from paying gift taxes unless you’ve already used up your $11.7 million lifetime exemption.

The person who receives the cryptocurrency will want to know the basis that you have in it so that they can calculate the amount of tax they will owe when they sell it. They will be responsible for paying tax on the total gain that is in excess of your basis, although it is possible that the amount of tax they pay will be lower than what you would have to pay if you had done it yourself.

A person in their sixties who has built a successful career is likelier to have a higher tax rate than a twenty-something with their first job. So, if you give some of your cryptocurrency to a younger relative, you can lower your tax bill.

Determining how much crypto tax you owe

You may estimate the tax you will owe using your income, profits, and losses.

How to figure out crypto income: People who live and work in the U.S. are used to having their federal and state income taxes taken out of their paychecks. Even if they aren’t taken out of your earnings automatically, you still have to pay these taxes on the cryptocurrency you earn from mining, staking, and rewards. Income tax is calculated based on your tax band and the amount you make. Caution: If you make money with cryptocurrency, you may move into a higher tax bracket and have a larger portion of your income taxed.

Determining capital gains or losses: To figure out whether you’ve gained or lost money, you need to know how much cryptocurrency you started with. This is what is referred to as your cost basis. By subtracting the purchase price from the final sale price, investors can determine if they made a profit or lost money when selling their cryptocurrency. You get a capital gain if the amount you sell the asset for is greater than your cost basis. If this is not the case, you have incurred a capital loss.

If you purchased cryptocurrency assets before they started to trend up in value, then investing your money in these assets could result in large rewards for you. If this happens to you, careful tax planning can lower your crypto tax liability.

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