Taxation of Cryptocurrency

What is cryptocurrency?

Cryptocurrency is a form of digital currency, which can be purchased in a variety of means; from exchange platforms such as Coinbase and Kraken, to some online banking platforms.

With the ever-growing nature of cryptocurrencies there will always be a new form or version of digital currency, such as NFTs. Some of the most well-known are: Bitcoin, Ethereum, Ripple and Luna – which has been hitting headlines for the losses it has created earlier this year.

Income Tax vs Capital Gains Tax

From a taxation perspective, cryptocurrency can be subject to both income and/or capital gains tax. The type of tax depends on the nature of how the income arises.

Both HMRC and the IRS have similar conditions in relation to when income tax is relevant to cryptocurrency.

If cryptocurrency is received as a payment for goods or services or could be considered a trade, under the badges of trade rules in the UK, its likely that it will be treated as self-employment income and liable to income tax rates and relevant national insurance contributions, or social security in the US.

If your cryptocurrency ownership is an investment, as opposed to a trade/earned income, then its likely treatment upon sale will be capital gains tax.

HMRC and the IRS have similar rules in relation to the sale of cryptocurrency outside of a trade/earned income. Capital gains tax will arise if the following disposals are made:

  • Selling cryptocurrency for any government issued currency, i.e. GBP, USD, EUR etc.
  • Trading cryptocurrency for another cryptocurrency or stablecoins; a digital currency pegged to a reserve asset such as GBP or USD
  • Spending cryptocurrency on goods and services, i.e. coffee/lunch
  • Gifting cryptocurrency

What about losses and how I can use them?

For those who have invested in assets/coins such as Luna and have experienced heavy losses, there are ways to utilise these against gains/other income.

The nature of the loss will dictate what it can be offset against, capital losses can be offset against capital gains, trade related losses have specific rules in the US and UK.

In both the US and UK, capital losses can be offset against gains in the same year, in theory reducing these to zero (or up the annual exemption in the UK). For US purposes, it is also possible to offset up to $1,500 against other income sources depending on your filing status and the amount of loss available/nature of loss (passive vs non passive). Any unused losses will generally be carried forward to use against future gains.

For Trade related losses, in the UK/US these are available to offset against other non-trade related income, however the concept of ‘worthless’ stock/shares could impact your ability to claim a loss. Luna as an example is worth practically nothing, but is not worthless, so would need to be sold to realise a loss.

Conclusion 

From both the UK and US tax perspectives, the nature of the transaction will determine whether or not a taxpayer will pay income or capital gains tax.

With the growing emergence of cryptocurrency, both HMRC and the IRS are taking steps to track cryptocurrency to ensure correct reporting.

HMRC now have a data sharing program with all UK exchanges and through this has transaction data dating from 2014 to the present. Letters to investors regarding reporting and payment of taxes is a matter of when rather than if.

The IRS has also enforced that all major exchanges must complete Know Your Customer (KYC) checks. This is as a result of the IRS winning court cases with the likes of Coinbase and Kraken, forcing them to share customer data. Taxpayers and the IRS will also begin receiving 1099 Forms which will indicate income earned and any taxes paid. Exchanges such as Coinbase will send its US customers 1099-MISC forms where there are crypto gains of over $600, and the individual is a US customer.

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