Taxation of Cryptocurrencies

Although the use of cryptocurrencies in business transactions is relatively small in contrast to the use of FIAT, the opportunities to increase tax revenues have become more apparent to governments. This has wide ranging effects on cryptocurrency investors.

IRS Notice 2014-21 states that virtual currencies may be considered as property for taxation purposes. Payments made using virtual currencies are subject to financial reporting. Essentially, losses and gains made from the sale of cryptocurrencies are subject to tax laws.

Under the notice by IRS, cryptocurrencies mined by Bitcoin miners are to be included in gross income at fair maket value as of the date of receipt. The IRS states, “If a taxpayer’s mining of virtual currency constitutes a trade or business, and the mining activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self- employment income and are subject to the self-employment tax.”

For users of cryptocurrency exchances such as Coinbase, data privacy may be of concern as Coinbase and other exchanges face increasing pressure from the IRS to provide them with information on their users for tax collection purposes. Coinbase has attempted to assist its users in meeting their tax obligations by introducing a cryptocurrency tax calculator. The tool is to be used by users and their tax professionals as reference to prepare their tax filings. First in first out and Specific Identification methodology are approaches that may be used in the application of cost basis to individual sales or exchange of digital assets.

In Japan, cryptocurrency investors may be taxed 15-55% of their cryptocurrency profits. Japan’s National Tax Agency classified profits made from cryptocurrency as miscellaneous income. It was stated that there was no need to declare digital currency gains “for those who have an income of ¥200,000 ($1,838) or less by selling virtual currency, provided there is no other income.”

While the benefits of increased tax revenues stemming from the cryptocurrency market may be appreciated, some may argue that the liabilities incurred for participants in a relatively young cryptocurrency market could stifle growth and interest in the markets. Taxation on the markets is necessary for future growth of not only cryptocurrency markets but other sectors of society but it is important for tax agencies to maintain a balance. Some may argue that the crash of cryptocurrencies is inevitable, therefore governments should gain whatever tax revenue possible while it lasts. This is a contentious notion that may not be far from the truth for some government agencies.

Regardless of the reasons for taxation in different economies, the benefits will be felt as cryptocurrencies add a new twist to the dynamics of tax liabilities. A donation in Bitcoin, for example, may allow a donor to deduct the value of their asset from their taxes as a charitable donation. The audit trail of blockchain means that it will also be easier to ascertain the provision and use of a cryptocurrency to a charity.

While meeting tax obligations may seem next to impossible as a cryptocurrency investor, Blockchain technology has the potential to enhance an individual’s capability to meet their tax obligations. As the technology develops, smart contracts could enhance the ability of individuals and organizations to meet cross-border transactions that are under tax laws of different jurisdictions. Transaction based taxes could be paid automatically to government agencies upon the execution of transactions, thus reducing the administrative costs of transactions.

For most, tax is rarely ever fun but it is necessary. For cryptocurrency investors, it could be even more important as much remains seemingly ambiguous in the legal sphere of cryptocurrencies.