Tag: cryptotax

Stablecoins 101: What Are They, How Are They Taxed, and Can I Use Them In My Business?

Cryptocurrency has significant business utility, especially in international transactions. Companies can exchange funds directly, without wiring fees or banking delays, and easily convert their native currencies into crypto and vice-versa using a mobile phone. However, traditional cryptocurrencies like Bitcoin and Ethereum are extremely volatile and their exchange values can easily fluctuate 10-20% or more in a matter of days or even hours. Market supply and demand forces determine the prices of these most popular cryptocurrencies and their value is particularly sensitive to various external factors. Events like China’s crypto clampdown, significant buys or sells by capital investors, or even Elon Musk’s tweets can crash the market or send the price of crypto soaring. Obviously, price volatility makes businesses and consumers reluctant to adopt these cryptocurrencies for day-to-day transactions. Price volatility translates into purchasing power uncertainty, which in turn devalues the currency.

Stablecoins are cryptocurrencies that try to solve the volatility problem. They do so by pegging their price to the price of another asset (such as the U.S. Dollar or an ounce of gold). For example, the USD Coin (USDC) can be acquired and sold for U.S. Dollars on a 1 to 1 ratio. USDC is actually backed by existing dollar reserves, meaning that each USDC has a real-world dollar counterpart held by regulated financial institutions. USDC reserves are also periodically verified by a third party (but not audited).

There are other stablecoins as well, for example Tether, Binance USD, TrueUSD, DAI, and more. Like USDC, some are tied 1 to 1 to U.S. Dollar reserves. Others are backed by commodities like gold, silver, or oil. The price of a commodity-backed stablecoin is tied to the market price of a commodity unit, like an ounce of gold. There are also stablecoins that attempt stability through overcollateralization using other cryptocurrencies. Finally, there are algorithmic stablecoins that automatically adjust the cryptcurrency’s supply to keep its market price within certain parameters.

Stablecoins are however still cryptocurrency. Even if the stablecoin has a pegged 1 to 1 exchange ratio with the U.S. Dollar, it is not the same as cash. For tax and regulatory purposes, the IRS treats all cryptocurrency as intangible property subject to capital gains tax. They may be subject to separate state-level regulation as well.

Paying for goods and services in stablecoin is a taxable event because the IRS treats it like a sale or exchange of an asset, which is subject to capital gains tax. Technically, if the stablecoin is pegged to the dollar at a 1 to 1 ratio, the capital gain is 0 and there is no tax owed. But the transaction must still be recorded and reported, just like if you were buying and selling a stock at zero net gain/loss. Otherwise, you risk attracting an IRS audit to determine whether you underreprted taxable income. Buying stablecoin for cash and holding it is a non-taxable event.

Receiving stablecoin in exchange for goods and services is a taxable event. It is not much different than receiving payment in fiat currency, which is income subject to tax. The fair market value of the cryptocurrency as of the date of receipt determines its value for income reporting purposes. With stablecoin, it is easy to calculate because of the 1 to 1 ratio. Receiving 500 USDC is the equivalent of receiving $500 cash. However, spending the 500 USDC is not the same as spending $500 cash – rather, the transaction is considered a liquidation of property (subject to capital gains). Again, if the value of the stablecoin is pegged to the dollar, you are not going to have capital gains. But you must still keep records and record the transaction. If you are using a stablecoin that is pegged to an asset like gold, its price will fluctuate and you may record a capital gain or loss.

Converting other cryptocurrencies into stablecoin and vice-versa is also a taxable event. The sale of the crypto is an asset disposition that is subject to capital gains tax even if the transaction is an exchange of one currency to another. Similarly, using stablecoin to purchase other cryptocurrencies is a sale of the stablecoin that must be reported as income, even if the the capital gain is $0.

Stablecoins are still risky and unregulated. Not all stablecoins are created equal and it is a mistake to think that “stablecoin” means there is no risk involved. The LUNA/TERRA debacle is a good example because TERRA was supposedly a “stablecoin” pegged 1 to 1 to the U.S. dollar, yet it was pegged algorithmically (meaning artificially without any actual assets or fiat currencies backing it). An algorithm that no one really understands is not the same backing as fiat in a vault or money market securities or corporate bonds or commodities portfolios. The bottom line is that without a uniform definition of “stablecoin,” users should at a minimum know what “stabilizes” the value of the purported “stablecoin.”

There are other hurdles to using stablecoins in day-to-day business operations. As cryptocurrency, they are still subject to government regulation. For instance, it is illegal under federal labor law to pay workers in anything other than U.S. Dollars. On the international scene, China recently tightened anti-crypto regulations, prohibiting financial institutions from providing crypto exchange services, which presumably includes stablecoins. At the same time, China is rolling out its “digital yuan,” which is a sovereign-backed virtual currency. United States regulators have also expressed interest in the “digital dollar,” in part to improve financial services access to unbanked or underbanked communities. Additionally, all cryptocurrency transactions are still subject to exchange fees imposed by the intermediaries, and there may be delays or additional processing costs associated with converting stablecoin into fiat currency. Widespread adoption by merchants and the public is a must for stablecoins to develop practical utility – but right now, holding a wallet full of stablecoin is not the most practical or liquid solution for most businesses. Nor does a 1 to 1 dollar stablecoin provide any investment upside and in fact periodically loses value due to inflation.

Finally, there are at least 36 different stablecoins available for purchase via most popular exchanges. It is unknown which stablecoin (if any) will enjoy widespread adoption and popularity sufficient to result in real utility for businesses. Further, stablecoins are not truly decentralized because a central entity is holding the collateral, which in turn must be audited or otherwise verified. If a holding entity starts issuing stablecoins that are not actually collateralized, this would cause hyperinflation and essentially render the stablecoin worthless.

Stablecoin certainly holds a lot of promise for business use, but only solves the problem of volatility. Reduced volatility comes at a cost of a centralized authority and reintroduces trust into the cryptocurrency equation. At the same time, sovereign-issued digital currencies are on the horizon and may very well dispel the need for and demand for stablecoin.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Ask the Crypto Tax Lawyer: Is Staking Income Taxable?

Yes, staking income – just like most other types of income – is taxable. However, the question is when? When you receive the staking reward? Or only when you sell or exchange the newly- obtained tokens? Under the first, more conservative approach, the token is actually taxed twice – once as ordinary income at the time of receipt and the second time at the capital gains tax rate when it is sold or exchanged. Under the second, more aggressive approach, the token is not taxed upon receipt and not subject to tax until it is sold or exchanged. The second approach also allows token holders to take advantage of more favorable long-term capital gains tax rates by holding the staking rewards longer than a year.

How is Staking Different From Interest?

What is staking? It is an arrangement to “lock up” or “stake” a portion of an owner’s crypto tokens in a staking pool in return for additional cryptocurrency over time. The return is often expressed as a percentage. This makes staking seem very similar to an interest rate paid on a certificate of deposit or savings account. Indeed, on Coinbase, staking rewards are expressed in terms of an APY (annual percentage yield) and the term “interest earned” is used synonymously with staking. Unlike proof-of-work mining, which validates new transactions through solving complex algorithms, staking is more energy efficient and environmentally-friendly. Staking allows network participants to nominate their coins to be used as validators and to guarantee the legitimacy of new transactions on the blockchain. In return for validating a new block, the owner receives new tokens; if the transactions validated are later found to be illegitimate, the validator may lose tokens through a process called “slashing.”

Although it may seem like interest income, staking income may not be taxed the same way. The IRS has not taken a definitive position on this question even as the deadline to file 2021 taxes approaches. One of the reasons may be because of pending litigation in Jarrett v. IRS. In 2019, Josh and Jessica Jarrett sued the IRS for a refund on taxes paid on staking income, arguing that cryptocurrency received for staking should not be. Recently, the IRS appeared to concede that staking income is not taxable at inception and agreed to issue the Jarretts a refund. However, the taxpayers rejected the IRS’s offer – instead, opting to push the Tax Court to make a definitive ruling on the issue and create binding precedent. In response, the IRS has asked the Tax Court to dismiss the case in light of the plaintiffs having obtained full relief and the absence of a “case or controversy” for the Tax Court to decide.

The Conservative Approach – Staking Rewards Are Taxed Twice

Intuitively, it may seem that income from staking should be treated the same as interest/dividend income from a savings account, which is incurred when the bank pays it out. In the crypto context, the IRS has taken a position since 2014 that with mining, the fair market value of the virtual currency as of the date of receipt is includible in gross income. Arguably, staking income is sufficiently similar to interest earned or mining to be treated the same. Depending on the terms of the staking arrangement or agreement, the cryptocurrency or token contributed is restricted much in the same way that cash in a certificate of deposit is locked in until maturity.

The Aggressive Approach – Staking Rewards Are Only Taxed When Sold or Exchanged

However, the counter-argument (and the taxpayer’s position in the Jarrett case) is that the tokens received as a staking reward have no value until they are sold or exchanged. In that sense, they are like manufactured product that may have value when created, but is not taxed until it is sold. The product has a market value when created, but the IRS does not impose a tax on it at the time of creation.

Further, fiat currency has tangible value when received – an interest payment of $25 has worth and buying power at the time of receipt. It does not need to be sold or exchanged to have value. Conversely, 100 Tezos tokens (at issue in the Jarrett case) have no buying power or value until and unless they are exchanged into fiat, traded for another currency, or used to pay for services. Yes, if you pay for services with cryptocurrency, you are taxed on any difference between the basis and the fair market value of services received. According to the IRS, if you buy 100 Tezos for $1 (a basis of $100) and then exchange those same 100 Tezos for $300 worth of legal services, you just realized a $200 taxable gain. Proponents of the more aggressive Jarrett approach argue that cryptocurrency or tokens received as staking rewards are more analogous to a manufactured product than fiat currency interest or dividends.

The Issue Remains Unsettled

To complicate the issue further, the IRS’s offer to refund the Jarretts’ tax and settle the litigation seems like a tacit endorsement of the second, more aggressive approach. Arguably, the IRS is conceding the issue and admitting staking income is only subject to income tax when sold or exchanged. However, this position is directly at odds with the IRS’s guidance on tokens received from mining. The IRS’s Notice 2014-21 on virtual currency taxation states that “when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.”

While the issue remains unresolved, taxpayers should consult with their legal and financial advisors on the correct approach for them. The conservative approach risks including too much in your gross income. The aggressive approach risks underpayment penalties in the future if the IRS does issue guidance and takes the same position on staking as it has on mining. But in any case, keep an eye on the Jarrett case, as the Tax Court may rule on this very question in the near future.


Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2022 Artaev at Law PLLC. All rights reserved.

Ask the Crypto Tax Lawyer: How Can I Reduce My Crypto Taxes?

Important: The information in this article applies to individual investors and LLCs that are taxed as pass-through entities. The rules are different for corporations and LLCs electing to be taxed as a corporation and are not addressed here. This article is for informational and promotional purposes only and, as always, you should consult with a professional about your specific tax situation before taking any action.

Despite its name, cryptocurrency or “crypto” is not really currency. For tax purposes, it is treated as “property,” which means it is taxed similar to stocks and bonds. As I previously wrote, buying and selling crypto is subject to capital gains tax. Paying for goods and services with crypto is likewise subject to capital gains tax. Exchanging one crypto asset for another is a taxable event as well.

“Crypto tax” has a nice ring to it, but it is nothing more than the application of ordinary capital gains tax to cryptocurrency transactions. The most important aspect of crypto investing – whether individually or as part of a business – is good record keeping. Exchange platforms like Coinbase can generate basic reports to use at tax time. But remember that you must also keep records when you pay for goods and services with crypto or receive payments in crypto. For tax purposes, when you pay someone in Bitcoin or Ethereum, the IRS considers that you have sold the cryptocurrency for cash (and realized a capital gain or loss). When you receive crypto as payment for goods and services, you acquired ordinary income in the amount equal to the market value of the crypto at the time of the transaction. In short, keep good records, you will need them.

What are some top strategies to minimize capital gains tax from cryptocurrency investing? As with any other investment, a little bit of planning can help you minimize your tax bill at the end of the year.

  1. HODL. The capital gains tax rate is different for short-term and long-term gains. Purchasing and selling crypto within a 365 day period is considered the short term, and any gains during that period are taxed like ordinary income (i.e. wages). Short-term crypto income will be taxed between 10% and 37%, depending on your tax bracket. On the other hand, selling crypto more than a year after buying it lets you take advantage of the lower long-term capital gains rate. Depending on your income level, long-term capital gains are taxed at either 0%, 15%, or 20%, with most people falling into the middle 15% bracket. For example, if you are paying a 22% rate on ordinary income, but are in the 15% bracket for long-term gains, you will end up with significant savings on your tax bill.
  2. Offset. Of course, not everyone buys crypto for long term investing. If you are trying to time the market and profit from crypto’s volatility, holding to gain favorable capital gains treatment may not be a feasible strategy. Tax law generally allows offsetting capital gains with losses, but the strategy does have limitations. Losses must first be used to offset gains of the same kind – for instance, short-term losses must be used to offset short-term gains, and only if you have excess short-term losses can you shift them over to reduce your long-term capital gains. If you still have remaining losses, you can take an ordinary income deduction of up to $3,000 for the tax year and retain the balance to offset next year’s gains and income.
  3. Decrease Taxable Income. Like with other “property,” you can time your sales to your specific income situation. You may want to sell appreciated crypto when you have less income than you anticipate in the future. Or, you may accelerate 401k/IRA contributions to take advantage of the up-front tax break. Health Savings Account contributions are another taxable income reduction alternative, especially if you are anticipating significant health care expenditures in the near future. For businesses, business expenses can be used to reduce taxable income, but be sure that the expense is both “ordinary” and “necessary.” For example, renting a building and paying electricity costs for your Bitcoin farm are probably ordinary and necessary expenses. Also, be careful to properly categorize any business start-up costs, assets, and improvements, which are treated as capital expenses (and therefore are different than your ordinary business expenses).
  4. Set up a self-directed IRA. Self-directed IRAs or SDIRAs are little-known but powerful investment tools for the sophisticated investor. They allow you to take full control of your retirement investments and direct the funds into non-traditional assets. Commonly used for holding real estate, private company stock, and precious metals, SDIRAs can certainly be used to buy and hold crypto. Most bank-managed retirement plans can be converted to the self-directed kind, but there are additional fees and special rules about what your SDIRA can and cannot do to retain the tax-favored treatment by the IRS. In essence, the SDIRA can be used to convert all or part of your retirement portfolio into an investment “checkbook” that you can then use to purchase and hold assets like crypto for the benefit of your retirement.
  5. Move, gift, donate, or leave it to your heirs. Depending on your situation, there are other options that may be used to optimize your tax situation. If you are in a state that imposes its own income tax, you may want to consider moving to a no income tax jurisdiction. Or potentially incorporating and locating your Bitcoin mining company there. Likewise, depending on your future goals, retirement situation, and estate planning, it may be advantageous to shift some of your crypto holdings (especially those where you are looking at a significant gain) towards those objectives. For example, if you leave your crypto portfolio as part of your estate, heirs would receive a “step up” in basis and receive the crypto at the fair market value at the time of death. This significantly reduces their tax bill and something to consider if a crypto portfolio is part of your estate planning.

There are other strategies that may be available based on your particular situation. Remember to keep good records, plan ahead, and get a professional to answer all your crypto tax questions.

Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

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