Crypto Taxes: Essential Knowledge for Every Investor
By Hennadii Cholovenko 453 2 Jun 2023
As most countries are progressively legalizing cryptocurrencies, they now require digital asset owners to pay taxes. Nevertheless, some specific strategies and guidelines can be employed to legally minimize or even completely evade tax liabilities.
In the early days following the introduction of Bitcoin and other digital assets, various governments didn't pay much attention to the cryptocurrency market. It was seen as a temporary phenomenon and a niche interest for tech enthusiasts, especially when compared to the well-established stock market, boasting a capitalization in the hundreds of trillions of US dollars. However, as the market began to surge, crossing the $1 billion threshold around 2013-2014, tax authorities in developed countries (such as the USA, Germany, Japan, Switzerland, Canada, and others) started taking notice. This attention led to the first precedents of tax code amendments accounting for the new class of assets. When the market capitalization of digital assets surpassed $1 trillion, most governments couldn't resist the urge to fill their coffers by taxing the ever-growing number of crypto enthusiasts.
Upon examining the countries that have legalized cryptocurrencies and started taxing them, two significant aspects emerge:
- The varied classification of digital assets
- The range of tax types
Cryptocurrencies are regarded as property, assets, virtual commodities, intangible or digital assets, and private money, among other things. Depending on the category they fall under, taxes can differ, encompassing progressive income/wealth tax, capital gains tax, or value-added tax (VAT). In many countries, mining is taxed separately as a commercial or entrepreneurial activity. Interestingly, in some jurisdictions, tax authorities might even be interested in ordinary eCommerce transactions if cryptocurrencies are used to pay for goods or services before being converted into fiat money.
Depending on the location, jurisdiction, and government stance on digital assets, tax rates can differ significantly. Democratic (non-exploitative) rates range from 5% to 20%, but in some countries, the maximum rates can become a substantial burden for cryptocurrency owners. For instance, in the US, the maximum rate is 37%, while in the UK, Japan, Australia, and South Africa, it can reach up to 45%. Sweden holds the record for the highest progressive income tax rate at 57%. Generally, the rate depends on various factors such as the amount of capital in cryptocurrencies, the number of digital assets at the end of the reporting period, incurred losses, or the volume of transactions conducted.
Ignorance of the Law Is Not an Excuse
Investors should be aware that owning digital assets attracts the attention of tax authorities, regardless of each country's specific cryptocurrency taxation regulations. Therefore, investors need to understand the basics, principles, and approaches to cryptocurrency taxation in their jurisdiction to comply with tax laws and avoid issues with tax authorities. Failure to comply with cryptocurrency tax requirements or late tax payments can lead to fines and other legal consequences.
Even minor violations of tax legislation related to the non-taxation of cryptocurrency profits can have severe repercussions in some countries, like South Korea, where such breaches can result in imprisonment. In the United States, the Internal Revenue Service (IRS) has increased its efforts to ensure compliance with cryptocurrency taxation. This includes issuing warning letters to investors who have inaccurately reported their earnings while holding digital assets in their portfolios.
Here are some tips for crypto enthusiasts looking to legally minimize or even avoid tax liabilities
Tax agent status: Information is only reported to tax authorities by companies with tax agent status in a specific country. For instance, most cryptocurrency CEX exchanges registered in the US, such as Binance.US, Coinbase, and Kraken, are local tax agents. These licensed trading platforms report the income of US citizens to tax authorities and the SEC. If a trader is not a US citizen and trades on another CEX exchange without tax agent status in their country, their transactions and balances won't be reported, at least for now.
Transactions between cold wallets: Conducting operations between cold wallets (hardware, mobile, or desktop) through decentralized exchanges (DEX), SWAP services, DeFi platforms, or decentralized protocols can keep cryptocurrency owners out of reach for regulators or tax authorities. These operations will only appear in blockchains and won't be subject to taxation since tax authorities lack the technological capability to identify them – and likely never will.
P2P and OTC deals: These off-exchange deals occur directly between asset owners and don't get included in an exchange's general statistics. Many independent services cater to such transactions, and most CEX exchanges have established P2P and OTC platforms, making them widely accessible while maintaining confidentiality.
Non-banking payment gateways: Using non-banking payment gateways allows users to convert to fiat currency without drawing the attention of banks, which act as local tax agents in each country. Similar payment services can be found in almost every jurisdiction. These services exist where financial companies hold licenses from international payment systems like Visa/Mastercard or use non-banking processing services (third-party processors). By using non-banking payment gateways, digital asset owners can move assets through the "fiat-crypto-fiat" scheme legally and discreetly, avoiding unnecessary scrutiny from banks and tax authorities.