Blog Crypto Crypto Tax: The Complete Guide for 2022

Crypto Tax: The Complete Guide for 2022

date December 24, 2021 time 6 min read 1863 views

Many people associate cryptocurrencies with evading the law, but the truth is, crypto traders don’t get a free pass when it comes to taxes. Gas fees in crypto and crypto tax are real, and you absolutely have to pay them. The system might seem overwhelming if you’re facing this prospect of paying them for the first time, but don’t just try to find the next cryptocurrency to explode in 2022, as long as you have a good understanding of how everything works, there’s nothing to worry about.

Nobody sees that January 1 is approaching and thinks to themselves, “I can’t wait to pay my taxes.” Even if you feel a sense of civic duty to pay them and relish the chance to support society, it doesn’t ease the pain when the moment comes for you to cough up. Yet taxes are an inescapable part of our lives—as one of the great Founding Fathers, Benjamin Franklin once quipped:

“Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”

In the US, few assets are exempt, and we have to pay a crypto tax. It’s frustrating to get your head around yet another tax rule, but trust us, you don’t want to miss this one. Don’t worry, we’ll break it down for you so you don’t get caught out.

Cryptocurrency tax explained 

Although we’ve been using the term “crypto tax” for simplicity, it’s important to note that cryptocurrencies don’t actually have their own tax category in the same way that “federal tax” or “property taxes” do. Instead, they come under the category of either capital gains tax or income tax.

Cryptocurrency tax might be a pain, but it’s important to understand it properly. (Source: Unsplash)

Yes, that’s right—depending on where you get your crypto from and how you handle it, the way you pay tax could be different. Let’s look at the difference.

Crypto tax vs capital gains tax

If you’re new to cryptocurrency taxes but this isn’t your first rodeo with investing in cryptocurrency, you might be familiar with the concept of capital gains tax. It’s a tax you pay on the gains your investment makes, defined as the difference between what you paid initially for an asset and what it was worth when you sold it.

There are two kinds of capital gains tax: short term and long term. If you sell something after owning it for less than a year, it’s classed as short-term, whereas anything you own for longer is subject to long-term capital gains tax. 

What’s the difference? Short-term capital gains tax works in the same way as income tax—for 2022, the income tax range will be between 10% and 37% depending on your income. Meanwhile, long-term capital gains tax rates range between 0% and 20%, and it also has different tax brackets.

Check out the full tables showing tax brackets for single and joint tax filers for a more detailed breakdown.

So far, this might be sounding surprisingly straightforward to get your head around. But unfortunately, as you’ll realize yourself when you think it through a little more, there are a lot of complications in the crypto world that we need to clear up.

Capital gains vs income tax

One of the caveats we’ve been hinting at is that, if you try to find the next cryptocurrency to explode in 2022 and earn your cryptocurrency, it’s classed as income—meaning it’s subject to income tax rather than capital gains tax. In practice, this means you’ll be taxed in the same way as you would if you paid short-term capital gains tax (since they have the same rates and rules), but you still need to know the difference when filing your taxes.

Crypto taxes work differently depending on where you get your cryptocurrencies from and how you use them. (Source: Unsplash)

So, which should you be filing?

Capital gains tax applies to anyone if you buy or trade cryptocurrencies and later sell them for a profit. It doesn’t matter if you exchange the crypto for fiat currencies like US dollars, other cryptocurrencies (in the case of crypto swaps), or even goods and services—as soon as you use or sell your crypto, it should make an appearance on your tax return. 

You might think you can bend the rules by using the ETH you bought for $200 that’s now worth $4,000 to buy a fancy computer, but that’s tax evasion.
However, there are a few cases when your crypto earnings count as income tax. These include being paid in crypto for providing services (like freelancing), earning interest from staking or decentralized lending products, mining income, and airdrops.

Are there any crypto tax breaks?

It would be great if we could end this article by telling you that there are some incredible crypto tax breaks for you to take advantage of. There’s no easy option here—but there are some possibilities worth exploring. 

Loss offsetting

The main way to save in taxes is by including “capital losses” on your tax form, which you can use to offset your “capital gains” further down the line. 

Let’s say you buy $1,000 of bitcoin but sell it for $700 a few months later and then use that $700 to buy Solana, which rises in value to $1,500. You can use that $300 loss to offset your $800 gain, meaning you pay tax on $500 instead of on $800.

You can’t get around paying tax on cryptocurrency, but you can minimize what you pay. (Source: Pixabay)

Some people employ an investing strategy known as tax-loss harvesting by selling their crypto at a loss solely to offset their gains. While this won’t exactly earn you anything, it saves you from paying the taxes and is useful for those with limited liquidity.

Whatever you do, don’t forget to report a loss. You can’t just offset your losses informally—you need to do everything by the financial literacy books.

Fair market value

A major complication of cryptocurrencies is that they fluctuate in value, which means there’s not one single way to figure out what price to put on your tax form if you’re continually buying cryptocurrencies at different prices. 

What are you supposed to do if you buy one BTC for $40,000, another BTC for $25,000 a few months later, and finally a third BTC for $45,000—all in the same tax year—and then you sell one BTC?

There are three main choices:

  • Highest In, First Out (HIFO)—the highest-value coin you have determines the value of the first coin you sell on your tax sheet.
  • Last In, First Out (LIFO) —the most recent coin you bought determines the value.
  • First In, First Out (FIFO)—the oldest coin you have determines the value.
How to handle tax on your cryptocurrency and get more profit from your cryptos? (Source: Pixabay)

Clearly, HIFO is the most tax-efficient—if the coin with the highest price determines the value of the first coin you sell for tax purposes, it means your capital gains will be minimal. However, inexperienced traders would be better off avoiding these kinds of complex strategies unless they have help from hiring a financial advisor, and sticking to FIFO like most traders. It’s better to lose out on tax gains than to get into trouble with the law.

Get the most of your crypto with MyConstant

Now you know how to handle tax on your cryptocurrency, there’s nothing standing in the way of you getting started with crypto investing and trying out innovative ways to get the most out of your investments and start compound interest investment.

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George Schooling

George Schooling

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