Cryptocurrency is taxable income; but only when you actually profit from it.
Not sure what that means? Then read on, this article explains the basics principles for understanding your taxable cryptocurrency income in Canada and the United States.
First off, this is a general overview of only two different countries with VERY different taxation laws. Do not use this article as tax or investment advice. This is here to help direct you and get you started on the right track.
If you are unsure of whether or not you will be taxed on your cryptocurrency holdings then check with your accountant or financial advisor. You can also fairly easily find this information on government websites.
Sorting Out Taxable Income
For starters, it’s important that you understand what your taxable income is. Your taxable income is not necessarily the total amount that you earned in the year.
Your taxable income is your total income LESS all of your tax deductions and exemptions. Taxable income is the final amount that you will be taxed on. The amount of taxable income is calculated by many conditions, including but not limited to; your dependents, employment status, and personal and business expenses.
Taxable income is not to be confused with “tax-brackets.” Your income tax bracket is a rough amount that your income is taxed. The basic rule of thumb is that the more you make the higher your tax bracket is. The same goes for your taxable income, where the higher your profits, the higher your rate of taxation.
The bottom line is that your taxable income includes your wages, salaries, any bonuses, and tips, as well as investment income and unearned income; which may include cryptocurrency.
First, we will look at Canadian income tax and then we will look at American income tax. If you do not live in either country, then make sure to check your government website for details. Or contact a professional in securities and assets.
Assets and How They Are Taxed
- Currency holdings are taxed with regular income rates. This does not change based on how long you have owned the British Pound, for example. There are no long-term capital gains on currencies. Currencies are simply taxed as income. The amount and regularity will vary from Canada to the United States. Also, the rate of taxation will change based on your overall income.
- Cryptocurrencies are not treated as currency/fiat currencies in either Canada or the United States. But there is a big difference from Canada to the United States on how mining and transactions are treated in terms of taxation.
- Gold is taxed as a collectible, which means it is only taxed when it is sold.
- This is very similar to your long-term cryptocurrency holdings. You are only taxed upon sale and gain (or loss) of value. The amount is determined by the fair market value; a concept that will be explained shortly.
When Is Your Cryptocurrency Taxed in Canada
If you are filing taxes in Canada, you need to know that Revenue Canada is concerned with two main forms of acquiring cryptocurrencies:
- Cryptocurrency bought through an exchange
- Cryptocurrency earned through mining
Cryptocurrency falls under Section 1256 contracts, which basically means that only when you profit from your cryptocurrency does it become taxable. That means that just holding, trading or using cryptocurrency is not necessarily taxable.
Your cryptocurrency is taxable when you need to report the “disposition” of cryptocurrency, which is only in the case of business income or capital gains.
So, when does cryptocurrency become taxable?
Tax consequences are possible under any of the following conditions if you:
- sell or make a gift of cryptocurrency
- trade or exchange cryptocurrency, including disposing of one cryptocurrency to get another cryptocurrency, and then profit off of the exchange
- convert cryptocurrency to government-issued/fiat-currency, such as Canadian dollars
- Or, if you use cryptocurrency to buy goods or services
Business v. Capital Gains
The following are common signs that may be considered as a business and therefore are potentially taxable by Revenue Canada:
- Your use of cryptocurrency is for commercial reasons and is also commercially viable, which means you are earning a profit from your cryptocurrency transactions.
- Your expenditure are undertaken in a businesslike manner. This might include preparing a business plan and acquiring capital assets or inventory.
- If you promote your product or service through advertisements etc.
- Or, if you demonstrate that you intend to make a profit. If you are unlikely to do so in the short term, this doesn’t matter. But while you build your business, you may be able to deduct your cryptocurrency losses.
There are lots of ways that might be construed as running a business. So it is important to keep records in the event that you need to make a case one way or another.
However, if your use of cryptocurrency does not go beyond that of barter transactions, then it is not likely considered to be a business. So, in Canada, you can make a certain number of barter transactions. Within a limit, these barter transactions are not taxed, so long as they do not present or act as a business.
But if you spend your cryptocurrency to buy items or pay others for services, you will not be taxed on that cryptocurrency because it is not considered an earning asset.
Capital Gains Income in Canada
Capital gains occur when the sale of cryptocurrency is for more than the original purchase price. In this case, cryptocurrency is not considered a business expense. The gains from any sale are included in your annual income total. However, in Canada, only half of the capital gain is subject to income tax.
Conversely, any capital losses resulting from a sale can be used to offset capital gains. However, you cannot use losses to reduce income from other sources, only from your cryptocurrency losses. So, you cannot apply the losses to your employment income.
Also, you can carry forward your capital losses if you do not have any capital gains against which to offset those losses for the year up to any of the preceding three years.
Mining Cryptocurrency and Taxable Consequences
Mining cryptocurrency is not necessarily taxable. It is not taxable if you are not earning a substantial income from it, which means that it does not fall under capital gains, nor does it exceed the status of a “barter transaction.”
If you mine and do not convert your cryptocurrency into fiat currency, or if you mine, but use your earnings for transactions, then your income may not be taxable.
However, once you are dealing with larger quantities of cryptocurrency and transactions you are likely getting closer to the taxable territory.
United States Crypto Taxation
Cryptocurrency is taxed in the United States differently than it is in Canada; as you might have expected. Most importantly, you need to know who you are filing your taxes with, and for many in North America, it is in both countries. So make sure you are getting your information correct! And hiring a professional is advisable for those who’s taxes are slightly more complicated.
According to the United States, IRS Notice 2014-21, Bitcoin and other cryptocurrencies are defined as property. Therefore, anything purchased with cryptocurrency can be as a capital gain. That means that how much you will be taxed will depend on the overall fair value of the cryptocurrency. Its value is also relative to however long you have held it.
Despite the fact that it is considered property, it is not treated as cash or bonds, which means that cryptocurrency is not taxed like a currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
Form 1099-MISC, Miscellaneous Income
In the United States, you are required to report all cryptocurrency expenditures and transactions; this is not the case in Canada. That means that in certain cases, cryptocurrency is taxed a little bit like cash.
The IRS requires that anyone who makes trades or payments of $600 or more to an independent contractor must record and report this on their taxes. Such transactions are reported on Form 1099-MISC, as Miscellaneous Income. Cryptocurrency transactions must also be reported on Form 1099-MISC. The exchange used to determine the value of the cryptocurrency that will be taxed is “fair market value,” which we will talk about shortly.
Moreover, cryptocurrencies are also subject to backup withholding. This is the same way that other payments are made in property. Backup withholding is a specified percentage withheld by the payers. The amount must be paid to the IRS on most transactions reported on Form 1099.
This also means that if you report payments made to you with cryptocurrency you will also need a taxpayer identification number (TIN) from the payee.
Wages, Mining and Trading
Essentially, if you operate any kind of business that accepts cryptocurrency, or if you have holdings, then the IRS requires you to treat your income in a way that is similar to any business activity, your cryptocurrency is taxable.
This includes mining and any third-party purposes. This is referred to as a TPSO; a third party settlement organization. In this case, you as the merchant are required to report these earnings using Form 1099-K.
The rule for the calendar year in terms of the TPSO is:
- that the number of transactions settled for the merchant exceeds 200
- and that the total amount of payments made to the merchant exceeds $20,000
Fair Market Value
This information is relevant for both Canadian and American taxation policies.
The fair market value (FMV) of your asset is determined based on the price that your property will potentially sell for on the open market. Fair market value is most often used for taxation and real estate.
The main point to understand is that FMV is different from “market value.” Market value is whatever the market will bear, which means that sometimes you will get more for your assets and sometimes you will get less. The difference is dependant on the market need or desire for whatever assets you are selling.
However, the fair market value is based on an assessment of prospective sales, not real sales. This often means that the value will be slightly less than the market value. Because fair market value is only the amount that might be applied. The amount is based on an ideal which makes it easy to unload an asset in the event that you need to make an immediate sale.
A clear example is in determining the value of your house. The market listing is the list price that you want to sell your place for. However, this is not the fair market value and is often more difficult to determine. But if you needed to sell your house quickly, or in the case of a foreclosure, then you would not likely get the market value for your property.
It is similar to the idea of “appraised value,” which refers to an asset’s value in the opinion of a single appraiser. To get this information, fair market value usually requires the knowledge of an appraiser.
In terms of your cryptocurrency holdings, the value is determined by the sales records from exchanges. This means you are responsible to keep a record of your holdings and their sales. The resulting capital gains taxation of your cryptocurrency holdings is then based on the fair market value, which depends on the relative strength of the market.
Fair market value is important for when you earn or lose value when you sell one cryptocurrency to buy another. This value then determines your capital gains or income from cryptocurrency.
Any way you look at it, it is time to start keeping records of your cryptocurrency transactions. And just like your traditional income, you will need to hold onto records for the past 6 years, (7 years in total).
If you are a business that accepts cryptocurrency, then you will also be allowed tax exemptions for your business. The exchanges used will provide you with your records.
If you need more information about taxes, check out our article: Inheritance Tax and Cryptocurrencies