Crypto taxes

Crypto taxes

Author: Amy Miller, CPA
|
Read time:  6 minutes
Published date:  22 October 2022
|
Updated date:  15 April 2024
The IRS taxes trading, mining, or acquiring digital assets, including cryptocurrencies and NFTs. Learn how using crypto affects your 2022 tax return.

How are crypto and digital assets taxed?

Crypto and digital assets—such as cryptocurrencies and NFTs—are taxed differently depending on the type of asset, how long you’ve held it, and in some cases, how you obtained it. If you’ve bought, traded, or mined crypto or digital assets in the past year, you’re required to report that activity on your U.S. tax return.

Important note: While we’re here to help you understand how taxes on digital assets work, we aren’t giving tax advice in this article. You should definitely check in with your own tax advisor.

How are cryptocurrency trades taxed?

The IRS treats cryptocurrency as property for U.S. federal tax purposes. This means that gains and losses on the sale or exchange of cryptocurrency are taxed the same way as capital gains and losses on stocks, bonds, and other investment property. 

Whenever you sell virtual currency in exchange for real currency (USD, Euro, etc.) or another cryptocurrency, it triggers a capital gain or loss on the sale. 

Capital gains

Capital gains and losses are classified as long-term or short-term: 

  • Long-term capital gains: Generally, if you hold an asset for longer than one year before you dispose of it, your gain or loss is long-term. Currently, the tax rate on long-term capital gains is no higher than 15% for most individuals, but as high as 20% for those with taxable income that exceeds certain thresholds

  • Short-term capital gains: If you hold the asset for one year or less, your gain or loss is short-term. Taxpayers pay ordinary income tax rates (or the marginal tax rate, which is a graduated rate applied to separate income brackets, up to 37% in 2022) on short-term capital gains.

Crypto mining taxes

Mining is the process of using computer equipment to create new cryptocurrency by solving complex algorithmic math problems that verify transactions on a blockchain network. 

When a taxpayer successfully mines virtual currency, the fair market value (FMV) of the virtual currency on the date they receive it is taxable. The rate the miner has to pay in taxes depends on whether they mine cryptocurrency as a hobby or a business.

How to report crypto mining on your tax return

The IRS uses nine factors to determine whether crypto mining is treated as a hobby or a business activity. Those factors include the time and effort the taxpayer puts into the mining activity, their dependence on the income, their intent to make a profit, and the overall mining profitability, along with other factors. 

Crypto mining as a hobby

Hobby income is treated as ordinary income by the IRS, which means that it’s taxed at the marginal tax rate, similar to income from your job. 

There are only a handful of deductions that a taxpayer can take for a hobby, so most of the income you derive from hobby mining would be taxable. 

Crypto mining self-employment tax

Business income is treated separately from ordinary income. If you mine cryptocurrency professionally, your earnings from mining would likely be considered self-employment income, subject to self-employment tax. The advantage of mining as a business is that you may be eligible to deduct business-related expenses, such as office space or computing resources, for tax purposes. 

Crypto compensation tax

Additionally, if your employer pays you with crypto, the FMV of the cryptocurrency paid as wages is subject to federal income tax withholding

NFT taxes

Non-fungible tokens (NFTs) are digital assets on a blockchain that have unique codes that can’t be replicated—these codes distinguish NFTs from one another. NFTs are typically a digital certificate of ownership; they often represent a form of digital media, like art, music, or videos. NFTs may also represent tangible assets like business contracts, property rights, or concert tickets. 

The “non-fungible” nature of these tokens distinguishes them from cryptocurrencies. Fungible assets like cryptocurrencies are interchangeable—meaning that one unit of the cryptocurrency has the same value as another unit of the same currency. Crypto investors exchange assets whenever they buy a cryptocurrency (like Bitcoin or Ethereum) or trade one virtual currency for another. NFTs, on the other hand, each have a unique value. 

Taxes on newly minted NFTs

Creators and minters are not taxed until they sell or trade an NFT.  

An NFT creator is the digital artist, musician, or designer who creates the work that is converted into an NFT. Minters are the ones who do the converting: They turn the creator’s digital media or certificates into digital assets and record them on the blockchain. The creator and minter of an NFT are often the same person or business entity. 

Taxes on NFT sales and trades

NFTs are typically purchased using a form of cryptocurrency, like Bitcoin (BTC) or Ethereum (ETH), or with another NFT. These sales trigger a taxable transaction for the seller, who must recognize a capital gain or loss (see above). 

For example, if you sell an NFT for 100 ETH when 1 ETH is trading for $100, it implies a value of $10,000 for that NFT at the time of sale. If you originally acquired the NFT with 100 ETH when 1 ETH was worth $10 (a total of $1000 at the time of purchase), your NFT sale represents a capital gain of $9,000. 

Taxes on NFT creator royalties

Any royalties that a creator earns from an NFT are taxed as ordinary income.

Royalties give the original NFT creator a percentage of the sale price each time the NFT is sold on a marketplace. Creators can fix a royalty percentage (usually 5% to 10%) in the smart contract, which is an automated protocol of terms that are clearly written into the blockchain during the minting of the NFT; this amount is automatically sent to the artist’s wallet each time a subsequent sale is executed. 

IRS tax guidance on crypto and digital assets

The IRS uses the term “ digital assets” to refer to cryptocurrencies, stablecoins, NFTs, and any other digital medium of value storage and exchange.

IRS Form 1040 (used by individual taxpayers to file their taxes with the IRS) includes a question that asks every individual taxpayer whether they have sold, exchanged, gifted, or disposed of any digital assets each year. The IRS has some guidance for answering this question: 

  • Form 1040 instructions

  • Notice 2014-21 (Released 2014): Guidance for individuals and businesses on the tax treatment of transactions using virtual currencies

  • Revenue Ruling 2019-24 (Released 2019): Guidance on the tax treatment of a cryptocurrency hard fork

  • IRS online FAQs: FAQs on virtual currency transactions

The IRS has also issued audit and penalty warnings to remind taxpayers to report digital asset transactions. But they haven’t issued any significant authoritative tax guidance on digital assets since 2019. Instead, the IRS has been posting, adding, and editing informal guidance through online FAQs without detailed information or notation about when they created or modified each one. 

Digital asset transactions continue to add new elements of complexity to taxpayer compliance. Individuals and businesses need more authoritative guidance to properly understand tax treatment and comply with the rules. In June 2022, Anthony Cimino, Carta’s Head of Policy and Regulatory Affairs, wrote to recommend that the Department of the Treasury and the IRS issue more guidance, through formal regulations, to offer certainty and clarity to taxpayers. 

Carta provides crypto fund administration for VC funds. If you’re ready to launch a crypto fund, our team can help you form it and provide administrative support through the fund’s lifecycle.

If your fund plans to invest more than 20% of assets under management in token holdings or other non-qualifying venture investments, you’ll work with a Carta Crypto fund administrator who has experience supporting registered investment advisors (RIAs) investing in crypto. 

Digital asset tax policy updates

We welcome input on tax policy topics you want to understand further. Please let us know your thoughts or requests at policy@carta.com

To stay up to date on tax policy and other matters affecting small businesses, sign up for the Carta Policy Weekly newsletter: 

Sign up to receive Carta’s Policy Weekly Brief:

Amy Miller, CPA
Amy Miller is a Certified Public Accountant and Director of Public Policy for Carta. Previously, Amy worked for tax policy organizations and public accounting firms, advocating for policy before Congress, the Treasury, and the IRS.
DISCLOSURE: This publication contains general information only and eShares, Inc. dba Carta, Inc. (“Carta”) is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.  All product names, logos, and brands are property of their respective owners in the U.S. and other countries, and are used for identification purposes only. Use of these names, logos, and brands does not imply affiliation or endorsement. ©2022 eShares Inc., d/b/a Carta Inc. (“Carta”). All rights reserved. Reproduction prohibited.