How Digital Assets are taxed in the US, an explainer

Guest post by Selva Ozelli Esq, CPA, Author of Author of Sustainably Investing in Digital Assets. Amid a Surge in the  Number of Digital Asset Investors, A Refresher on How It  Is Taxed in the US

During 2023 there has been a worldwide surge in the number of digital asset users.  According to data presented by AltIndex.com,  following a digital asset bear market in 2022, the 2023 price rally rebuilt confidence in digital assets, drawing more users.  The number of people using digital assets as a payment method or investment hit 670 million during 2023 increasing 57% from 350 million worldwide users  in 2022.  According to Statista, the years between 2019 to 2023 saw an exponential growth in NFT users as well growing from 0.41 million in 2019 to 13.95 million in 2023.  These figures in digital asset use are expected to jump further in 2024.

How are Digital Assets taxed, a refresher

Contributing to this growth in 2024 is  the Securities Exchange Commission’s (SEC) landmark approval of eleven Bitcoin Exchange-traded funds (ETFs) on January 10th that are traded on stock exchanges and could hold significant implications for the $2 trillion digital asset market.

BTC ETFs are designed to track the performance of Bitcoin allowing investors to gain exposure to BTC without needing to consider a digital wallet, exchange, or self-custody. These BTC ETF’s which took over a decade of efforts by fund managers to get the ETFs listed include  Grayscale Bitcoin Trust GBTC, BlackRock’s iShares Bitcoin Trust (IBIT), ARK 21Shares Bitcoin ETF (ARKB), Bitwise Bitcoin ETF (BITB), Invesco Galaxy Bitcoin ETF (BTCO), WisdomTree Bitcoin Fund (BTCW), VanEck Bitcoin Trust (HODL), Franklin Bitcoin ETF (EZBC), Fidelity Wise Origin Bitcoin Trust (FBTC), Valkyrie Bitcoin Fund (BRRR) and Hashdex Bitcoin ETF (DEFI).

James Butterfill, Head of Research at CoinShares, the author of CoinShares’ weekly digital asset fund  research details the impact that the SEC approval of the ETFs could have on the industry.

BTC EFT share Investors should be aware of the pricing dynamics of these publicly traded BTC funds. The market value of BTC ETFs shares can differ from  the NAV of the Bitcoin traded on various exchanges on the internet. This discrepancy arises from the differing  supply and demand in the BTC ETF shares in the stock market as compared to the larger BTC market.  BTC ETF shares may trade at a premium (above the real value of Bitcoin per share) when demand is strong. On the other hand, amid less advantageous market circumstances, the BTC ETF shares might trade at a discount.

Investors who own BTC via an ETF are taxed the in the same manner as BTC hodlers. In 2014, the IRS issued Notice 2014-21, 2014-16 I.R.B. 938, explaining that BTC is treated as property for Federal income tax purposes.  The Frequently Asked Questions on Virtual Currency Transitions expand upon the examples provided in Notice 2014-21 and apply those same longstanding tax principles to additional situations.

Tax Reporting Requirements of Digital Asset Hodlers

If an individual  taxpayer during 2023 has not sold, exchanged the digital asset he or she bought at the end of  2022 or beginning of  2023 and is still holding them, then there is no taxable event to report on his or her U.S. tax return.

Tax-reporting requirements would arise if the taxpayer held these digital assets in a foreign financial account and if mandatory financial thresholds were met under Foreign Bank Account Report (FBAR) and Foreign Account Tax Compliance Act (FATCA) reporting requirements, according to a letter from the American Institute of Certified Public Accountants (AICPA) to the Internal Revenue Service (IRS).

FBAR: A taxpayer with a financial interest in or signatory authority over a foreign financial account must file a foreign bank account report (FBAR) FinCEN Form 114 if the aggregate value of the foreign financial account exceeds $10,000 at any time during the calendar year. Noncompliance with FBAR would subject a taxpayer to steep civil and criminal penalties. Each nonwillful failure to file violation can carry a civil penalty of $10,000. Penalties for each willful violation could be the greater of $100,000 or 50 percent of the amount in the account.

FATCA: A taxpayer with foreign financial assets of $50,000 or more must report it for FATCA purposes on Form 8938. It is recommended that cryptocurrency-invested hedge fund accounts and cryptocurrency-denominated exchange accounts be reported in the summary information in Part I of Form 8938. Specific information should be given in Part V. Noncompliance with FATCA could subject a taxpayer to taxes, severe penalties in excess of the unreported foreign assets, and exclusion from access to U.S. markets.

Taxation of Transactions in BTC ETF Shares

Transactions in BTC ETF shares are handled the same way as any other kind of property when it comes to taxes. Capital gains tax will be imposed on individual taxpayers’ earnings from the selling of BTC ETF shares.

If an individual taxpayer sells shares of  BTC ETFs at a profit, he or she will pay capital gains tax, just like with regular ETFs. The duration of the ETF share holdings (classified as short-term or long-term) determines the tax rate.

Long-term capital gains, which are gains on assets kept for more than a year, typically have lower tax rates capital gains tax between 0%, 15%, or 20%, contingent on individual  taxpayers’ total taxable income and filing status.

Short-term capital gains, are taxed as ordinary income on assets held for less than a year at 10% and 37%, depending on individual taxpayers’ total taxable income and filing status.

Form 8300 Digital Asset Reporting Requirement is Suspended

Effective January 1, 2024, the  Infrastructure Investment and Jobs Act  modified the reporting rules for taxpayers engaged in business, treating digital assets as equivalent to cash for Form 8300 reporting purposes when the amount exceeded $10,000.

The Form 8300 report must be electronically filed (if they are required to file certain other information returns electronically) within 15 days after receiving the digital assets by  the recipient who must obtain the payor’s name, address, tax identification number, date of birth and the nature of the payor’s occupation.

Failure to file the Form 8300 within 15 days of receipt of a digital asset resulted in both civil and criminal penalties.  Additionally, the willful failure to file a Form 8300 is considered a felony.

See:  https://irishtechnews.ie/is-dr-craig-wright-satoshi-nakamoto/

However, on January 16, the Treasury Department and Internal Revenue Service (IRS)  released  Announcement 2024-4 which suspends the digital asset reporting requirement until the Treasury and the IRS issues regulations before it goes into effect.  Businesses are not obligated to report the receipt of digital assets of more than $10,000 in one transaction (or a series of related transactions) on Form 8300 until specific regulations are issued.

“The IRS’s temporary suspension of Form 8300 reporting for digital assets marks a pivotal moment in the evolving landscape of cryptocurrency regulation. It underscores the need for a balanced approach that recognizes the unique nature of digital transactions, while also ensuring transparency and compliance with tax laws.

The United States, while not among the countries with the lowest crypto taxes, shows variability in tax rates across different states, with some states like California having high income-tax rates and others like Wyoming and Texas being more crypto-friendly due to their regulations and tax incentives. Ireland, on the other hand, doesn’t feature prominently in the low-tax jurisdictions for crypto assets, indicating a more conventional approach towards crypto taxation.

Considering the diverse crypto tax landscape worldwide, this regulatory shift could significantly impact the United States’ position in next year’s crypto tax rankings, potentially making it a more favorable jurisdiction for crypto transactions” explained Sergiu Hamza CEO of  Coincub which issued  Coincub Tax report here.

Selva Ozelli Esq, CPA

Author of Author of Sustainably Investing in Digital Assets Globally https://www.wiley.com/en-sg/Sustainably+Investing+in+Digital+Assets+Globally-p-9781119885627.  I contribute opinion articles to The Irish Tech News, Cointelegraph https://cointelegraph.com/authors/selva-ozelli, Crypto News https://crypto.news/author/selva-ozelli/ which are republished by over 200 publications around the world and translated into 43 languages.

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