I’ve written a Tax Brief discussing long-term U.S. tax planning for cryptocurrency investors. Every such investor must be fully aware of the potential tax traps and planning opportunities involving cryptocurrencies. My Tax Brief runs the gambit from absolute disaster and financial ruin to extremely favorable taxation, including in some cases, cryptocurrency gains without federal or state taxation. Here are excerpts from my Tax Brief – you decide whether spending $9.95 for this information is worth it:
Beware – Major Tax Trap!: Trading in cryptocurrencies carries a huge tax risk! Losses from one calendar year cannot be carried back to offset gains from prior years. This drawback often occurs with day traders of securities and others who do not understand how the capital gain and loss rules work. Consequently, taxpayers can generate a huge tax without retaining sufficient assets to pay it.
Cryptocurrency As Payment For Goods or Services: Receiving cryptocurrency as payment creates ordinary business income, but the asset is subject to capital gains and losses, so the cryptocurrency recipient has ordinary income as to the fair market value of the product being sold or service performed, whether or not the cryptocurrency thereafter increases or decreases in value.
The Lesson: Be cognizant of your gain or loss position and make sure you sell loss positions by the end of the calendar year to offset gains during the year. Selling the loss positions in the subsequent year can lead to disaster because you cannot carry them back. For merchants and service providers, make sure your cryptocurrency transactions comprise a fraction of your business transactions or sell them immediately to protect yourself against a devaluation; remember, your income is based on the price of the product or service sold and not the subsequent value of the cryptocurrency.
Tax-Planning Concept: A C corporation is a separate taxpaying entity. Prior to 2017, C corporations were taxed at a maximum federal rate of 35%; the 2017 tax act lowered the corporate tax to 21%. This compares favorably to the highest federal individual tax rate of 38.8%. However, if a C corporation makes dividend distributions to individual taxpayers, the dividends are taxed at capital gains rates, so there is a potential double tax on corporate income, once at the C corporation level and again at the shareholder level. If the goal is to invest and reinvest in cryptocurrencies (or any other investment asset, such as stock or securities) for the long term, the initial savings in taxes by using a C corporation should outstrip the potential for a shareholder-level tax down the road. The earnings of the corporation may be used to fund family real estate ventures or other investments, without triggering a tax on dividends. Note: with careful planning, state income taxes can be avoided as well. A C corporation can protect you against individual liability if disaster strikes in the form of gains in one year and losses in a subsequent year.
Conclusion: Savvy taxpayers should consider investing through a C corporation to reduce taxation and for personal asset protection. At a minimum, investors need to thoroughly understand how capital gains and losses work, since IRS considers cryptocurrency property, an asset, and not the equivalent to actual currency. Thus, every transaction with cryptocurrency is taxable.