Dave Lemke, CPA
Mar 7, 2023
One of the first questions anyone investing in crypto asks me is, “Do I have to pay tax on this?” In the tax accountant vernacular, what they’re asking is, “Do I have to include crypto trades in my gross income?”
Gross income is the starting point for determining the amount on which you pay tax each year. The US Internal Revenue Code (a.k.a. the Tax Code or just “the Code” if you’re a cool CPA) has a section that succinctly explains what is taxable. It reads:
“Gross income means all income from whatever source derived…” (IRC §61)
In other words, pretty much everything is taxable. ::Cue sad trombone::
Regardless of how we make money, we must pay tax on it. Anything from the spare change dropped into a street performer’s hat to an investment banker’s big bonus, it’s all taxable. Even illegal bribes and kickbacks fall into the category of taxable income; just ask Al Capone, who was able to skirt every felony conviction except tax evasion.
It’s important to note that the Tax Code doesn’t mention reporting as a factor as to whether it’s taxable. For example, during college I made most of my money playing gigs in restaurants, at weddings, or in studio recording sessions. Rarely did I receive a Form 1099 to report to the IRS what I was paid. Nevertheless, I would report all the income on my personal tax return because it’s taxable whether or not I received a 1099.
The same is true of gains or losses earned in the crypto space. You may or may not receive a 1099, but it’s reportable on your income tax return regardless. In fact, the IRS reinforced this by releasing a list of Frequently Asked Questions in 2014 specifically related to crypto. Question #42 specifically addresses this topic:
Q42. If I engage in a transaction involving virtual currency but do not receive a payee statement or information return such as a Form W-2 or Form 1099, when must I report my income, gain, or loss on my Federal income tax return?
A: You must report income, gain, or loss from all taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction, regardless of the amount or whether you receive a payee statement or information return.
While we don’t have much clarity from the government on exactly how crypto, staking rewards, and other decentralized finance earnings are taxed, here are a few helpful rules of thumb:
Keep track of your basis. If you sold a bitcoin for $25,000 USD, you could have made money or lost money depending on when you bought it. Write down on a spreadsheet or one of many crypto software providers to track what you paid for your tokens and when.
Keep track of your expenses. Did you buy a stack of liquid-cooled video cards to earn that mining income? Those are business expenses that can be deducted either immediately or through depreciation, as well as most other expenses directly related to the production of income.
Always report earnings. It might feel like crypto is completely anonymous, but you might be surprised what the IRS already knows. Don’t play the IRS audit roulette, because the house always wins.
Even though it’s clear that you do have to report crypto earnings, the specific tax law around complicated on-chain transactions can be murky at best. Is that airdrop taxable? Is my staking income taxable? When I wrap ETH, does that constitute a sale? The devil is in the details, and you should reach out to a tax professional. Professionals may also help you increase your tax efficiency, for example, by selecting higher-basis tokens to be disposed of first or identifying expenses that could be allocable to your profits.