Crypto Tax Tips: Fundamental Keys To Minimizing Your Tax Debts...

in crypto •  2 months ago  (edited)

Tax season is nearly here again.

And sure enough, there are probably a few people in crypto who don’t know the optimal way to handle their accounting to minimize their amount handed over to the government.

When I was trying to figure out how to manage the whole tax matter in 2017-2018, it was a pretty stressful endeavor. There were a few points that seemed pretty straightforward, and others that remained a bit more ambiguous. Having been earning in Steem and diverting portions of those earnings into many different tokens across various exchanges and taking out different amounts at different times, things got fairly complicated without anyone clearly knowledgeable in how to deal with such an arrangement that never really existed before.

What follows are some pointers and tips I learnt along the way that may be helpful to others here who could be stressing over how to do their accounting to minimize their owing.

THIS IS NOT FINANCIAL ADVICE.

Regulations are different from country-to-country, and are continually changing. Some of what is written here might not be applicable to your situation. It would be advised to consult with more than one tax, accounting, and legal professionals who are up-to-date on the most recent regulations in your country regarding taxation of cryptocurrency.

With that said, let’s continue...



First Things First...

Before worrying about the specifics of how taxes work when it comes to crypto, it might be best to get clear on one fundamental point: *whether you’re treating yourself as an individual when it comes to your filings, or a business.

Here in Canada, you don’t actually need to register a business to file as a sole proprietor.

And that first choice can make a big difference in how much you end up paying.

Why? Business write-offs / expenses.

File as a sole-proprietor, and you can quickly begin to minimize your owings by accounting all sorts of things as business expenses, from a fraction of your rent & utilities to the “entertainment costs” of eating & drinking out, to all sorts small purchases that are in some way or another related to your activities as a sole-proprietor. Add up all those little expenses, and you could be quickly looking at thousands of dollars saved in taxes paid that would not be able to be deducted if filing as an individual.

These are basics.

Yet, it is upon these basics that are built the next key perspective of approaching the matter of taxation around crypto - that tokens can be considered an asset.

Thus, a business expense.



Key Crypto-Tax Principles...

In both the U.S. and Canada, there are three basic classifications which determine the taxation rate on crypto earnings.

  1. Income earned in crypto is considered the same as any other income - taxable at the full rate of any other income at its value the specific time it was received.

  2. If trading crypto, profits are considered as income, taxable at the same rate; losses as losses.

  3. Capital gains/losses: profits or losses made on long-term investments (typically held more than one full year).

Now, you may encounter individuals who say things such as, “because crypto isn’t considered legal tender, no taxes are required to be paid on them” - whether that crypto is income or trading/investing profits/losses.

And while there may be some merit to what they say, it would be well-advised to do your thorough homework on the premises for such arguments.

Irregardless of such arguments, there are certainly significant risks of failing to claim crypto earnings. Some might be willing to take the risks and fight the legal system based on philosophical/moral premises, however it is very possible that should a person get audited somewhere down the line and found out that they weren’t accounting for their income honestly, jail time wouldn’t be a surprising outcome. And bear in mind, despite misconceptions of crypto being anonymous, there’s always a trail left on the blockchain.

Meanwhile, understanding these key rules of the game as it is - moral or not - and how to strategize carefully in combination with other facets of the tax game such as utilizing business write-offs as a sole-proprietor (or corporation) could reasonably enable a person to minimize their taxes owed to nothing, while remaining fully compliant and playing by the rules.



The Complications Of Steem...

Now, for the majority of the population who are earning money in the conventional fiat system, and may be simply getting money into and out of crypto through a limited number of exchanges, accounting for trading & investment gains and losses would be a pretty straightforward matter.

Though for those who’ve been earning in Steem, things can quickly become much more of a headache.

Technically, Steem earned would still likely be considered income - taxable as income as the value its paid out at. Yet, the nature of Steem’s system makes that much more difficult to account for due to a couple of reasons:

  1. Both Steem and SBD rates continually fluctuate, and it’s pretty much guaranteed that by the time you would cash out, it’d be at a different rate - thus, requiring more detailed calculations of profits/losses on top of the initial income. (Unless you cash it all out directly and consider that final amount converted into fiat as the income.)

  2. The uncertainty of how to treat the portion of rewards distributed in Steem Power. (Unless you power down within the given tax year and simplify its accounting as income, as noted above.)

  3. How to track precisely the value of payouts in your local currency, if you’re not taking profits immediately & treating those final withdrawals as income.

One lawyer I spoke with here in Canada who knew his stuff when it came to crypto still seemed a bit confused when it came to the unique dynamics of Steemit. However, his take was that earnings in Steem Power couldn’t technically be considered income until the point they were converted back into liquid Steem...

Though the complication there becomes one of, how do you account for the exact value of the Steem Power when it was first earned, so you can then calculate the according profit/loss of its value when withdrawn, if the Steem Power has been held for more than a year? (Which you’d want to do, because those would then be considered capital gains/losses, taxable at half the rate of income).

If you’re not beginning to get confused yet, you might not be following along, as these are some tricky matters that don’t have a 100% crystal-clear solution.



Multi-Dimensional Transactions...

To jump back a bit, let’s retouch on a basic legal premise...

When a cryptocurrency is sold, it is considered a taxable transaction. (Whether at the income rate during trading, or capital gains/loss rate investing.)

Now, one key point that needs serious consideration if you want to minimize your taxes while still remaining fully compliant: the type of trade most of us make in crypto of one token for another is sort of a double transaction - both the sale of one token and the purchase of another, simultaneously.

Without factoring this key point into one’s accounting strategy, a trader could potentially be setting themselves up for taking a big unnecessary hit.*

(And this partially goes back to the point from above: a token may be considered as an asset, thus a business expense.)

To make things clearer, let’s use an example:

Say you’d invested $10k in ETH early 2017 at $10, held until the peak, and then sold for BTC when it was $1000. 100x / $1 million in profit sounds like a great return.

So, tax season comes. And if you were to follow the generic counsel, entrusting yourself to an accountant who didn’t fully understand the particulars of this investment class or one of those software programs that’s supposed to simplify your crypto tax accounting, you might very well be on the hook for paying tax on that $990,000. (Anywhere from $300-500k if the ETH was held less than a year, or $150-250k if more.)

Now, where are you going to get those funds to pay?

Remember, you didn’t profit in fiat currency.

And as BTC crashed from $20,000 back down $3500, you lost the majority of those “profits” you made on the ETH sale.

So what do you do now? Sell those BTC holdings for their $175,000 value, still come up short to pay the IRS, and then wait until the next tax year to claim a $825,000 capital loss...?

Now, you could have ridden out the gains & losses without it affecting your tax matters - if you strategized and accounted accordingly.

Because that sale of ETH wasn’t in essence a single trade - but for accounting purposes, the simultaneous sale of ETH and purchase of the BTC assets - on which there cannot be any profit/loss claimed until the time of its sale.

*Are you beginning to see how it’s critically-important to understand this stuff...?

Sure, we could delegate our entire matters to one of the very few tax accountants who are somewhat familiar with the unique details of this innovative environment that is crypto.

Though considering the fundamental importance of managing your own keys, passwords, and security of funds in crypto... *would you really be willing to trust just one professional opinion and hand over the management of your personal tax strategy to someone who could potentially overlook one such key that could end up costing you insane amounts of money, versus diligently learning the ins-and-outs of how to approach securing your own financial position through deliberate planning in the midst of a regulatory environment that’s still plagued with uncertainty and the influence of the old, corrupted, centralized financial giants...?



Simplification...

A couple years ago, I had heard the approach to crypto-tax was simple: only claim what you pull out into fiat.

As I dove deeper, I discovered that would be a potentially-risky strategy, as it doesn't exactly line up with the official regulations. However, there still is some merit to that approach, when understood correctly and utilized properly for simplification purposes.

When I had my tax guy do my filings last year, after all was said and done, he punched out a final figure of a yearly 2017 income of around 13k - having deducted all other business expenses first. Though I had tallied up all those other expenses, they didn't all individually need to be presented in the filings.

Similarly, it might be reasonable to approach the crypto-taxes.

IF there are concrete profits, capital gains, or capital losses than occur when a sale of crypto takes place into fiat dollars, then yes, you'd be wise to account them.

Though as for the minute details of those two-sided crypto-for-crypto transactions that stay in the crypto domain... well, again - this isn't professional advice, so you might wanna consult with a knowledgable accountant if you've been doing alot of trading - however, it'd probably be safe to leave what stays in crypto out of the official upfront accounting & filing - while still retaining full records, so that in the case if you ever did get audited and needed to account for everything, you could.

So while technically you may "supposed to" be required to file the details of all trading activity... if, like in the case where my tax pro handled it, the key figure you need to file are net income, then it might be less headache for everyone to leave the whole paper trail of your crypto activity as an entirely different set of accounting - *pulling over just the net income/profits and capital gains/losses in fiat as the conversions were made into fiat.

Again, I'd advise to consult with a professional to gain complete clarity on this.

And if you're actively trading, you're alot less likely to get away with attempting this, given you're constantly turning a profit - versus long-term buy-and-hold investing, which becomes the domain of capital gains/losses.

However, this may be a bit more detail on what some mean when they say "only claim what's converted into fiat" - providing a clearer understanding of how that perspective aligns with the more-strict one of apparently needing to account for all trading/investing activity.

Piecing these points altogether...

While that all constitutes for some key points to be aware of, now comes how to put them together for the purpose of minimizing your owing to the government.

Off the bat, you've conducted yourself as a business. So, you can write off 1/3 or so of your rent & utilities as office expenses, travel, eating & drinking out as entertainment expenses, etc.

You're now aware that if you're frequently trading, your earnings are going to be taxed at a full income rate, whereas profits made off HODLing for a year or more will be taxed at half the rate as capital gains.

So, let's say... what are you going to do with your Steem earnings now?

If you're not in a rush to get them out and pay bills, it might make sense to buy some other crypto to hold.

Why?

If you consider the sale of Steem as two simultaneous transactions - selling Steem and purchasing ETH, for example - it has zero impact on your net income figure that you are responsible for accounting in your filing. Instead, it's spent directly on an expense of the new ETH asset.

Now say you hold the ETH for a year, and at that point, decide to cash out into fiat.

If ETH has gone down in value, you file a capital loss. If it goes up, it's now a capital gain - taxable at half of the rate of income.

Had you cashed in out right away, you would've owed the government approximately 30%. But by acquiring the business expense of purchasing the ETH asset, your net income fails to increase - and when you do cash out much later on, that is capital gains income, for which the taxable rate is much lower.

Delayed gratification at its best.

AGAIN: you'd be a fool to take my word for this and try file your own taxes based on these perspectives. CONSULT WITH A PRO who knows how to do the filings properly, as it could make a world of difference between the strategy working flawlessly and ending up in serious trouble.



The Digital Nomad Discount...

Last short point to mention...

I'm not sure if it's the same in the U.S. or other countries, but in Canada, citizens are only required to file tax returns if they were residing in the country for more than 180 days out of the year.

For the digital nomad and/or adventurous cryptoheads who possess the freedom to pick up and roam the globe, this presents quite the opportunity when it comes to taxes.

Let's say you make $100k in crypto.

After the taxman gets his cut, you may have anywhere from $50,000-$85,000 left.

But if you took that million profit during a year in which you spent 6+ months travelling, you wouldn't be obliged to pay those taxes.

(And surely, those saving alone could fund a decent six month world tour).

Food for thought.

Would entirely depend upon the filing requirements of your country.



As you might see by now, there are valid reasons for many of us in crypto - especially those earning fair amounts in Steem - to stress out when approaching tax season.

Yet, there’s also the opportunity for an incredible amount of empowerment when putting in the time to understand how to custom-tailor a strategy fit to one’s individual situation, rather than delegating everything to some “expert” who probably isn’t up-to-speed on every fine detail of this leading-edge technology.

And that’s not to say it’d be advisable to do it yourself. Hardly. The more you have invested, the wiser you’d be to utilize the services of a competent professional.

It may take a few hundred bucks more for their services than if you were to use one of those software programs to do it on your own, but it may be well worth it.

Between the months of research I’d been doing to figure out how to manage my own affairs, consulting with a lawyer versed in crypto, and a tax pro, it was the full-spectrum of perspectives - and the creative thinking activated through my exposure to them - which got me to a point of confidence in how to do my accounting such that I knew it’d be fully compliant while minimizing my tax burdens. And that confidence would not have been completed, had I not chosen to do my filing through the tax pro with decades of experience in his game.

Of course, we’ve each got our own unique situations - some with barely any crypto who’ve done little-to-no trading or investing, and others who’ve done tons and have nearly everything in crypto.

Utlimately, I feel that any of us would be foolish to rely on anyone else to tell us how to manage our own affairs. If sovereignty is a personal goal, then the diligence is required in figuring out how to manage one’s own affairs - which is equally as true for the tax side of things as it is for managing wallets and such.

Once again: nothing above is financial advice.

That said, I hope there’s been some interesting food-for-thought and perspectives that may be of value to some of you as you move forward in doing your own research, consulting with your chosen legal & accounting professionals, and come to figuring out your own individualized approach to your crypto-accounting and tax filing this season.

Put all the pieces together, manage your business wisely, and you may end up having the government give you a rebate rather than owing them... 🙏

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Really for these subjects, like a child, I need you to explain it to me with plasticine and foami. I'm ignorant about it! In my country, Venezuela, we are also in the time to pay taxes, but two years ago I declared myself in rebellion. In my country nothing works and taxes are getting bigger and bigger. The minimum wage for a Venezuelan is 5 dollars a month, which is only enough for half a meal a single day. The Venezuelan has looked for all forms, until he had 3 jobs in the day, to be able to eat half a meal. I don't know how we could get a bill like that. It is unfair for a country to take our money and not see it reflected in any work. When you feel that you are investing in improvements for the country, there is no doubt: PAGA. But when the taxes go into the pockets of the corrupt, think well. I hope I don't attack anyone with my opinion. Once again without light in Venezuela. Greetings

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I don’t know how taxes there work at all, though I figure it’d be safe to say that you have far less to be concerned about that those with significant amounts in the US or Canada, and would be fine to not claim anything at all. Seems the government there really doesn’t have their shit together and pursuing minor tax evasion for crypto would be far lower down on the priority list.

Of course, I could be wrong.

Good stuff @rok-sivante. Luckily accountants here in NY are quite familiar with crypto nowadays.

Dropping this here in case it may be useful to someone - free script to count 2018 income from transactions and rewards:
https://steemit.com/taxes/@gaottantacinque/steemit-taxes-calculator-free-script-to-calculate-the-sum-of-your-incoming-transactions-and-rewards

Take care 🙂👍

Excellent article. Until May 27 last year, the Finnish Tax Authority considered crypto-crypto trades non-taxable. On July 2, they announced that they were going to tax all crypto-crypto trades effective May 27 and afterwards. I stopped trading immediately. But as a result, my portfolio may be less than ideal. Oh well, I'm hoping that alts will pop at the end of the next bull run. I will cash them out through BTC and use what they call "presumed acquisition cost" (translation), which is 20% or 40% for assets owned longer than 10 years.

Steem income is trickier. I haven't traded or cashed that out, either. So I only need to calculate the values of each SBD, STEEM or SP at the time I received them. Because no reliable day-to-day values exist (odd spikes happen from time to time), I'm going to group them on a weekly or a monthly basis. There are simply too many events.

Thank you for your advice. But I don't have many assets, so the amount of tax I have to pay is not much .

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and you live in a country where you probably don’t even have to bother filing... :-)

Taxes are an easy way for governments to get money without having to work. I think like that @rok-sivante.

Nice post!

I have been doing the worst thing of all. Ignoring it. This year I am gonna have to do something about it though. Thanks for reminding me!

I may just have to incorporate or otherwise shoot for business status. Seems like the smartest (but most tedious) way>

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Depends on overall strategy.

A corporation MIGHT be good IF you’re doing a lot of trading and want to minimize taxes on INCOME. But that also depends on how you intend on moving funds out of the corporation and/or reinvesting them. And, it COULD end up more headaches with management and accounting than worth it, depending on exactly what you’re up to.

Sole proprietorship could be a simpler option. OR, in Canada, you don’t even have to actually register a proprietorship to still treat yourself like a business for tax purposes and write off expenses.

Again - many factors, depends on larger gameplan, and good to consult with multiple parties to gain different perspectives to help inform well...

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Yeah. I was thinking more along the lines of an LLC which are fairly cheap and simple to set up and maintain here. My town has more lawyers and accountants than you can shake a stick at! Most of them hungry :-)