Cryptocurrency has a Special Role in Income Taxes

Cryptocurrencies have been around for longer than you think, and we’ve only heard from the Internal Revenue Service (IRS) twice – in 2014 and 2019 – on how they think crypto should impact your tax burden.

From the beginning, the IRS has designated virtual currency as property. Because of this identification, cryptocurrencies are subject to capital gains taxes.

What is Crypto or Virtual Currency?

The most popular cryptocurrencies are house-hold names by now – Bitcoin, Ethereum – but there are thousands out there that you haven’t heard of.

All crypto or virtual currency is a digital representation of value that works outside of national currencies. But just like currency, crypto can be used to exchange value in terms of transactions.

While being marked as “property,” crypto has some of the same properties and characteristics of stocks and are subject to rising and falling values like any investment.

One reason people are pursuing cryptocurrencies is because it is secure. Transactions are encrypted with specialized computer coding and put into a blockchain. A blockchain is essentially a public ledger that lives in the digital world.


How do Cryptocurrency and Long-Term Capital Gains Work?

At the onset of cryptocurrency popular, the IRS made sure to put out an initial notice to secure their piece of digital currency income.

That ruling – IRS Notice 2014-21 – stated that the IRS considers cryptocurrency to be property. As property, it is subject to capital gains taxes that are reported on Schedule D and Form 8949 if necessary.

If you hold your cryptocurrency for more than a year, any profits are considered long-term capital gains and are subjected to those tax rates. If you owned your crypto for a year or less before spending or selling, profits are classified as short-term capital gains that are taxed at your ordinary income rate.

If you are worried about how you’ll be taxed, our team of tax strategists can help. There are also tables available online for the current year’s short-term and long-term capital gains tax rates.


The 2019 Revenue Ruling and What It Means

In 2019, the IRS released their first updated guidance on cryptocurrency in five years. Many questions needed answering on how to handle some of the interactions of virtual currency. To understand the 2019 guidance, we’ll need to explain two actions first.

Hard Forks

The easiest way to think of a hard fork is when you receive a new credit card if your old one is thought to be compromised. In crypto, the currency on one of those distributed public ledgers undergoes a change that results in a permanent move away from the initial ledger. Sometimes this creates a new cryptocurrency.

The most famous hard fork occurred in 2016 when the Ethereum blockchain included a crowd-sourced venture capital fund called The Distributed Autonomous Organization (DAO). An error in the blockchain code of the DAO enabled someone to steal $45 million in cryptocurrency from the DAO. DAO leadership used a hard fork to create a new cryptocurrency. This made the old cryptocurrency worthless and deprived the digital robber of that $45 million.


Each cryptocurrency holder has a digital wallet. An airdrop occurs when virtual currency is distributed to the wallet address, typically for free. The goal of an airdrop is to create awareness and broad distribution for a blockchain project. It can also be used in hard forks, distributing new cryptocurrency to the holders of the old cryptocurrency.

The 2019 Revenue Ruling provided FAQs with some answers, but also raised more questions about the future of cryptocurrency and taxes. Here’s some of the things that are explained:

  • If a hard fork happens and you receive the same fair market value of new cryptocurrency that you had in the old cryptocurrency, no gross income is recognized.
  • If you get airdropped a new cryptocurrency, then you have an accession of wealth and you must recognize that new cryptocurrency as gross income of that date.
  • If you transfer virtual currency from a digital wallet or account belonging to you to another wallet that is yours, this is a non-taxable event.
  • If you receive virtual currency in exchange for providing services, you recognize ordinary income. Your basis in the virtual currency is the fair market value when the currency is received.
  • If you receive cryptocurrency as a gift, no income is recognized until you sell, exchange, or somehow get rid of the currency. Your basis in the virtual currency gift differs depending on whether you will have a gain or loss when you sell or get rid of the holding.


Some Advice from The Richest Doctor

In David Auer’s book, The Richest Doctor: A Modern Parable of Financial Independence, there’s a ton of information about understanding risk and investing smarter. It’s important to learn and know what type of investor you are – the “Too Busy to Learn” investor, the “Accredited Investor Level,” or one of our higher levels. Although the book is for physicians, there is great advice for all high-income professionals.

If you are prepared to learn the ins and outs of cryptocurrency, the better chances you have of investing and understanding the ramifications of gains on your tax picture. We recommend reading up, finding a mentor that is already successful in cryptocurrency investing, and also reading The Richest Doctor to understand how investing and cryptocurrencies might play a part in your financial independence.

There are a lot of nuances to cryptocurrencies. There’s much more to crypto than we could cover in this article. Good luck with any moves you make in this space, and don’t hesitate to reach out to the Provident CPAs team with tax questions!

What to Know about Tax Brackets and How They May Change

What are the income tax brackets and how do they work? Here is an overview.

Key takeaways:

  • There are seven tax brackets currently ranging from 10% to 37%
  • You don’t pay the same percentage on all your income; each portion of income is taxed at a different rate
  • The Biden Administration has said it wants to increase taxes for the wealthy, so it’s important to be prepared if this applies to you
  • You may be able to fit into a lower tax bracket by claiming credits and deductions

Paying taxes each year requires that you plan in advance for what you’ll owe, especially if you run your own business. A big part of a tax strategy is understanding the current tax brackets and how they may change in the future. These brackets mean that every American does not pay the same percentage of tax on their income each year; those who make less pay less, and those who make more pay more.

So, what are income tax brackets, and which one do you fall under? Here’s an overview of what tax brackets are, rates for 2021, what could change with the new Biden Administration, and how to get into a lower bracket. 

What are income tax brackets?

Tax brackets outline what percentage of income Americans have to pay based on their annual income. They were first created in 1913, when the top tax bracket was just 7 percent and the lowest was 1 percent. 

Today, there are seven total tax brackets. For tax year 2021, these range from 10% to 37%, according to the below guidelines, which have slightly higher income limits than 2020:

  • 10%: individual filers with income between $0 and $9,950; joint filers with income up to $19,900; and heads of household with income up to $14,200
  • 12%: individual filers from $9,951 to $40,525; joint filers between $19,901 to $81,050; and heads of household between $14,201 and $54,200
  • 22%: individual filers between $40,526 and $86,375; joint filers between $81,051 and $172,750; and heads of household between $54,201 and $86,350
  • 24%: individual filers between $86,376 and $164,925; joint filers between $172,751 and $329,850; and heads of household from $86,351 to $164,900
  • 32%: individual filers from $164,926 to $209,425; joint filers between $329,851 and $418,850; and heads of household between $164,901 and $209,400
  • 35%: individual filers between $209,426 and $523,600; joint filers from $418,851 to $628,300; and heads of household between $209,401 and $523,600
  • 37%: individual filers and heads of household making $523,601 or above and joint filers with $628,301 or more

This tax bracket system is a “progressive tax” approach, again meaning that people making more money pay more in federal income taxes. However, keep in mind that just because you fall into one of these tax brackets doesn’t mean that you are taxed that rate on every penny you make. Each portion of income is taxed at the corresponding rate.

For example, if someone makes $60,000 in 2021, the first $9,950 of that income is taxed at 10%, the portion from $9,951 to $40,525 is taxed at 12%, and the rest is taxed at 22%.

What could change under the new administration?

With each new U.S. administration comes potential new tax laws and priorities. The Biden Administration has indicated that it will implement higher taxes on wealthier Americans, so if you make over $400,000 in income each year, you may see an increased rate. This may mean that top rate could get a boost up to 39.6% from 37%.

This online tax calculator can help you plan for taxes if Biden’s plans go into effect in the near future.

The new administration has also proposed other tax changes outside of brackets, including an increase to the child tax credit (up to $3,000 from $2,000), and an increase in the child and dependent care credit (up to $8,000 from $3,000).

How to fit into a lower tax bracket

If you’re worried about paying a lot when tax season rolls around again, there are a few ways you can reduce your burden. First, deductions lower taxable income, so with enough of them, you may be able to get down into a lower bracket. Common deductions are charitable donations, medical expenses, mortgage interest, home office expenses, vehicles, and student loan interest, among others.

The other option is taking advantage of tax credits. These don’t impact which bracket you’re in, but they reduce the amount you must pay. Credits you may be eligible for include the child tax credit, the earned income tax credit, or the residential energy credit, though there are many others. 

You can potentially lower your tax burden significantly with these strategies. This is why it’s crucial to work with a tax professional who can help you claim all credits and deductions you’re eligible for.

Work with a tax professional to save more money

Each year, there are new laws and guidelines to know and implement while planning. Make sure you never miss anything by working with a tax professional who knows each new regulation or legislation, in addition to what might be coming next. 

The team at Provident CPA and Business Advisors is ready to help you with everything tax-related. Contact us to learn more about our business growth and strategic tax services.