Whether you're into play-to-earn crypto games or have several digital currencies in your investment portfolio, you should know that you have to pay taxes for your virtual currencies under the current tax code.
You should also know that in 2022 the bipartisan leadership introduced in the U.S. the Virtual Currency Tax Fairness Act. This bipartisan bill aims to create a workable structure for taxing purchases made with virtual currency, aka cryptocurrency, in an attempt to strengthen the legitimacy of digital currencies in today's economy.
Let's dive in and learn what the new bipartisan legislation proposes.
How does the IRS define Cryptocurrency?
The IRS considers cryptocurrency as an example of a convertible virtual currency that can be used as payment for goods and services, digitally traded between users, and exchanged for or into real currencies or digital assets. Virtual currency is considered a property in federal taxation. For example, the tax principle of property transfers applies to transactions made with digital currencies.
Can IRS track everyday digital payments?
The answer is yes. The IRS can track any personal transactions made with virtual currencies through trading platforms or cryptocurrency exchanges, among other methods. They receive a direct report of all transactions made on the exchanges and platforms. The IRS is aware of your digital asset transactions if your trading platform issues you a Form 1099-B or 1099-K.
Regardless of the amount or whether you received a payee statement or information return, you are required to declare income, gain, or loss from any taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction.
Taxation of virtual currency transactions
The Internal Revenue Service says that the sale or other exchange of virtual currencies, or the use of virtual currencies for retail payments or even small everyday purchases or holding virtual currencies as an investment, generally has tax consequences that could result in tax obligations. In short, if the digital assets used in a transaction have increased in value, the taxpayer would be subject to capital gains tax under the current law.
As far as the current tax code stands, whenever crypto is used, a taxable event occurs. People could feel discouraged from using crypto payments as an everyday method because of the surprise taxes.
Let's say one uses crypto tokens to buy groceries and other small personal transactions. That person would owe capital gains on the transaction if the digital asset appreciated, even if the increase is only a fraction.
Do you have to report Cryptocurrency to the IRS?
The Internal Revenue Service asks everyone to report their digital assets on tax returns. You should include all crypto and NFT transactions or if you exchange digital assets with other assets, goods, and services.
Will the IRS know if you don't report crypto?
Absolutely. You risk fines and penalties if you still haven't submitted Form 8938 with your crypto earnings after the due date and if any extensions have passed. The IRS will contact any taxpayer who hasn't finished their annual return or reports after an initial failure to file.
The Virtual Currency Tax Fairness Act
U.S. Senate Banking Committee ranking member Pat Toomey and the democrat senator Kyrsten Sinema introduced the Virtual Currency Tax Fairness Act last year, meant to simplify the americans' everyday lives. The bill is intended for people that wish to buy or sell virtual currency and use that currency for micro-transactions.
The bill creates tax exemption by treating cryptocurrencies similarly to how foreign currency is treated. It exempts from taxation small personal transactions that use crypto for goods and services. Crypto users wouldn't have to report any transactions up to $50 or any trade in which they earn less than $50.
The Responsible Financial Innovation Act is another proposed bill that contained a $200 exclusion on purchases with crypto.
As the daily use of digital currencies increases and crypto becomes more and more mainstream, it becomes clear that tax reporting simplicity for small crypto purchases is a must. The decentralized blockchain infrastructure generally depends on small transaction fees that burden users with compliance friction. The new legislation would relieve cryptocurrency users, allowing them to keep more of their own money in their wallets and help the industry thrive.
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