Boy oh boy do we have an important topic today. First, we are legally obligated by the American eagle that watches us sleep at night to tell you this is not financial or tax advice – this is just entertainment that you may possibly find useful, but we can’t officially recommend anything.
Secondly, you should know we are leaving our political views out of this – as we always do with our videos on this channel – we strive to create content that is void of political commentary unless it is specifically connected to the topic we are teaching about, so that our videos can stay high quality and informative.
Let’s dig in.
Capital Gains
The first thing you need to know is there’s this term called “Capital Gains”. Capital Gains is whenever you buy something like a car or a house or a gold coin and it goes up in value. When it does that – the IRS wants their fair share. However, they only ever ask for their fair share when you sell it. In short, if you buy something and it goes up in value, and then you sell it, the USA’s IRS wants to collect money on it as a tax.
Well, Cryptocurrencies fall under that category. When you buy and sell or trade any cryptocurrency, you are legally obligated to tell the IRS how much you made, and then also it is your responsibility to calculate how many taxes you owe.
What they really care about is how much money you made in profits from your crypto going up or down. So, as we always do, let’s run through some examples to better understand this.
Example
Let’s say you buy some Doge at .25 cents, and you spend $500 so you now own 2000 doge. A few days later, it goes up to .30 cents and you sell all your 2000 doge for $600. This video’s second vocabulary word is “Cost Basis” and that’s a fancy term to call the price at which you originally bought your Doge. Your cost basis was 25 cents. Your sale price of the asset was 30 cents, so your profit was 5 cents on each transaction, and since you transacted 2000 times, you made $100 in profits.
Bought doge for $500, sold for $600 in one week. This is as simple as it gets.
So the IRS wants you to tell them that you earned $100 in capital gains and that you should calculate how much you owe them and then use that number to pay them. What you pay them, currently in 2021 is correlated to how much money you make gross each year. So if you make $50,000 a year, you fall in the 22% bracket – which means that you’ll owe $22 of your $100 of gains to the IRS.
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Loophole alert! If you want to pay less taxes, there is something every billionaire knows about – it’s called long-term capital gains. So the way the IRS currently does their tax schedule, they will tell you if you wait more than 1 year to sell it, you don’t have to pay as much taxes on it. They classify it as a “long term capital gains” instead of “short term capital gains”.
So if you look at the same chart, you’ll see the $50,000 bracket is only 15% for long term capital gains – which is lower than our short term tax of 22%. So if you waited one year before selling, you would owe $15 instead of $22 on your capital gains to the IRS.
So waiting more than one year is a huge benefit, especially if you have a ton of money locked up – because saving 7% for large transactions could equate to a lot of money. As you can see in the chart, as we make more and more money, we also save more by holding.
If we made more than $500,000 in income, we would pay 37% short-term capital gains tax, compared to if we waited a whole year and only paid 20% long-term capital gains tax. That is a 17% difference, and if you’ve got $1,000,000 in ethereum gains, that’s equal to saving $170,000 just by waiting one year. The billionaires I mentioned earlier know this, and it’s something you should know too.
How does the IRS know?
So at this point in the video, you may be considering tax evasion, however that is not something we can recommend or educate you about. But you should be educated on exactly how the IRS knows that you made money.
Well, if you use a major centralized exchange like Coinbase or Binance or Gemini, whenever you sell or trade your crypto – they will snitch on you. Essentially, they keep a track of how much money you make from selling any crypto and report it to the IRS at the end of the year.
So if you found a way to cash out your crypto while keeping the value of it and avoiding these major exchanges that report to the IRS, that would technically be considered tax evasion. The IRS wouldn’t know you sold it, so they couldn’t charge you tax on it.
Technically, when I was like 15 years old I would go around to my neighbor’s yards and mow them for $20. By the end of the summer I had a few thousand dollars. I evaded taxes because I didn’t report that money. It was income I earned and I didn’t report it to the IRS. This is illegal.
The issue is… there was no trail – I was paid with cash, so the IRS would really have to do some digging to find out where and how I made that few thousand dollars… then they could calculate the tax I earned, and realize it wasn’t much, so it’s not worth them to go down that rabbit hole. So most people getting caught for tax evasion when it comes to cryptocurrency are the ones cashing out hundreds of thousands of dollars without paying taxes. You should know that the IRS and SEC are currently struggling to figure out how to do track all of these cryptocurrencies, and there are many people who assume if they hold their crypto long enough, the government may go “We can’t regulate this or track this, so we aren’t going to tax it”.
Back to the big exchanges. They only report what you sold. So if we go back to the doge example – Coinbase would only say “Theodore made $600 selling doge”. If I don’t tell them that I bought it at $500, I would owe tax on the WHOLE 600 – which sucks, but it is our responsibility to show that we bought it at $500.
So you definitely want to keep track of your cost basis (which is what you bought at) and your selling price if you are trading cryptocurrencies… and if you’re curious, yes there is software out there that will allow you to import your accounts from major exchanges and they will automatically calculate your short and long term capital gains.
Mining income
This wouldn’t be an all-around tax video if we didn’t include money you made from Mining or Staking – two BIG components to earning money with cryptocurrencies.
The IRS sees staking and mining income as that – income – not capital gains. So you are taxed in your normal income bracket… but here’s the kicker. If I mined .05 ethereum a week ago, I only pay income tax on what that ethereum was worth at that time. So let’s say a week ago it was $1000. This means at the time I mined it – I only mined $50 worth of ethereum. However, that was a week ago, and now my ethereum has doubled – it’s worth $100 now.
So I immediately owe income tax on the $50 that I mined – there’s no way to get around that.
However, since my ethereum went from 50 to 100 in value – I might owe capital gains on that. Here’s the important part: The capital gains is only triggered once you sell.
So if I sold my ethereum today and it was worth $100 – I would also immediately owe short-term capital gain taxes on the $50 I mined, and then the $50 of capital gains. Otherwise, I don’t have to sell and I don’t have to pay any capital gains taxes for the crypto just sitting in my account.
I am currently mining ethereum, and I personally keep track of my mining income through an excel sheet. If you’re curious, have a look at it.
When it comes to other rewards like staking, they are taxed the exact same way. You are taxed at the value of what those rewards are worth in USD when they were given to you, and then also taxed on the difference of them when you sell.
So in short, there are 4 things you need to know:
- When you buy crypto, then sell it… you owe taxes on money you make.
- Any trade in crypto is actually you selling the first crypto, and then buying the second one.
- If you hold your crypto for more than a year and then sell, you owe less taxes based on how longterm and shortterm capital gains currently works
- If you mine crypto, keep a log of what you mine and the price of how much you get that day – this is taxed as income. If you ever decide to sell it, you would pay capital gains on the difference between what you sold it for and what the price was when you mined it.
Hopefully this guide clears some things up for you – as when we got into cryptocurrencies, the videos on Youtube were a bit confusing. Anyways, thanks for watching, leave a like to reward our hard work on this video and consider subscribing if you want more amazing content like this in the future!
