Interpreting US Cryptocurrency Taxes General Taxation, Cryptocurrency Taxation, and Future Development Trends

US Cryptocurrency Taxes General Taxation, Cryptocurrency Taxation, and Future Trends

Author | TaxDAO

This article aims to introduce readers to the basic situation of US crypto taxes, including three parts: general tax system in the US, crypto tax system, and future development trends.

1 General Tax System in the US

1.1 Overview of General Tax System

The general tax system in the US is a complex tax system mainly based on income tax, with federal, state, and local governments legislating and collecting their respective income taxes, as well as other taxes as supplements. In the US, each level of government has independent tax and collection powers, forming a three-tier tax system of federal, state, and local taxes.

“Mainly based on income tax” means that income tax occupies an absolute advantage in the total tax revenue of the US government. According to the fiscal year 2022 report published by the US Internal Revenue Service, the total federal government tax revenue in the US in 2022 was $4.9 trillion, of which individual income tax accounted for $2.8 trillion (57.1%), corporate income tax accounted for $0.4 trillion (8.2%), social security and healthcare taxes accounted for $1.4 trillion (28.6%), and other direct taxes accounted for $0.3 trillion (6.1%).

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“Complex tax system” refers to a tax system in which a country or region levies both direct and indirect taxes. In the US, the federal government, state governments, and local governments levy both direct and indirect taxes. The difference is that the main sources of tax revenue for the federal government and state governments are income taxes, while local governments rely mainly on property taxes (over 70%).

1.2 Major Direct Taxes

1.2.1 Income Tax

The US individual income tax is a direct tax levied on the worldwide income or domestic income of US citizens, residents, and non-residents, and is collected at the federal, state, and local levels. Among them, the US federal individual income tax uses a progressive tax rate system, and the tax brackets vary depending on the taxpayer’s filing status (single, married, head of household). For example, for single filers, income below $11,000 is taxed at 10%, while for head of household, the tax bracket is $15,700.

In addition to federal individual income tax, taxpayers may also need to pay state and local individual income taxes, depending on the state and region in which they reside. Different states and regions have different tax rules, deduction items, and preferential policies. Some states and regions have progressive tax rates for income tax, while others have a flat tax rate for all taxable income.

Similarly, US corporate income tax is also levied at three levels. Since January 1, 2018, the federal corporate income tax rate in the US has been unified at 21%, eliminating the previous progressive tax rates of 15% to 35%. In addition to federal corporate income tax, US companies are also required to pay state corporate income tax. Currently, 44 states and the District of Columbia levy state corporate income tax, with the highest marginal tax rate ranging from 2.5% (North Carolina) to 11.5% (New Jersey). 15 states impose progressive tax rates on corporate income, while the remaining 29 states and the District of Columbia have a flat tax rate tax system.

1.2.2 Social Security Tax and Medicare Tax

In the United States, Social Security tax is a tax used to provide benefits to U.S. citizens and residents for retirement, disability, unemployment, or death. It mainly includes payroll tax (FICA), railroad retirement tax (RRTA), unemployment tax (FUTA), and self-employment tax (SECA).

Take the payroll tax as an example, it is a tax jointly paid by employers and employees to fund social security and Medicare programs. Among them, the social security program provides basic living security for the elderly, survivors, and disabled individuals, while the Medicare program provides medical services for individuals aged 65 and older and certain disabled individuals. In 2023, the tax rate for payroll tax in the United States is 15.3%, with 12.4% allocated to social security and 2.9% allocated to Medicare. Employers and employees each contribute half, which is 6.2% and 1.45% respectively. The social security portion of the payroll tax has a maximum limit of $160,200, and any amount exceeding this limit is not subject to tax. In the Medicare portion, although there is no maximum income limit, individuals with income above a certain threshold need to pay an additional 0.9% additional Medicare tax.

1.2.3 Estate Tax and Gift Tax

Estate tax is a tax levied on the property left by an individual to beneficiaries upon death, collected at both the federal and state levels. The federal estate tax applies to property worldwide, while state estate tax applies only to property within the state. Gift tax, on the other hand, is a tax levied on property gifted by an individual during their lifetime, collected only at the federal level.

In terms of exemption amounts, the estate tax and gift tax exemption amounts are calculated together. This means that property gifted by an individual during their lifetime affects the estate tax exemption amount after their death, and any amount exceeding the exemption amount is subject to corresponding tax. Both federal estate tax and federal gift tax use a progressive system, meaning higher-value property is subject to higher tax rates. In 2023, the federal estate tax exemption amount is $12.92 million, and the highest progressive tax rate is 40%.

In addition to the above-mentioned exemption amounts, there is also an annual individual gift tax exclusion. In 2023, the gift tax exclusion for U.S. citizens to non-spouse recipients (regardless of whether the recipients are U.S. residents) is $17,000. This means that gifts made within the annual exclusion amount are not subject to reporting or taxation for U.S. taxpayers.

1.3 Main Indirect Taxes

1.3.1 Sales and Use Tax

Sales and Use Tax is a tax imposed by U.S. state and local governments on the sale price of certain goods and services. There is no sales and use tax at the federal level, only state and local governments have the authority to impose it. Currently, 45 states and the District of Columbia have implemented sales and use tax systems, with only five states – Alaska, Delaware, Montana, New Hampshire, and Oregon – not having a statewide sales and use tax.

Sales and use tax rates vary by state, ranging from 2% to 10%, usually consisting of state-level rates and local-level rates. Local-level rates include rates for counties, cities, or other special areas.

1.3.2 Excise Tax

Excise tax is an indirect tax imposed on specific goods or services (such as fuel, tobacco, and alcohol) sold, collected by the federal government and states. Federal excise tax primarily applies to items such as gasoline, aviation fuel, tobacco, alcohol, and telephone services, while state excise tax is levied according to each state’s own regulations.

Unlike sales and use tax, excise tax is a tax imposed on specific goods or services, usually set by the government to regulate and suppress the consumption of these goods or services. It is sometimes referred to as Sin Tax because it often targets harmful or unhealthy products such as tobacco, alcohol, and fuel. The tax has two main forms: specific tax imposed on quantity or fixed value, and ad valorem tax imposed on value proportion. For example, the federal government imposes a specific tax of 18.4 cents per gallon on gasoline, a specific tax of $1.01 per pack of 20 cigarettes, and an ad valorem tax of 10% on tanning services.

1.3.3 Capital Gains Tax

Capital gains tax refers to the tax levied on realized capital gains of taxpayers who are not primarily engaged in the buying and selling of real estate and securities. Capital gains refer to the proceeds obtained from the sale or exchange of capital assets such as stocks, bonds, and real estate, usually equal to the selling price minus the purchase price and other expenses.

In the United States, capital gains tax is divided into short-term capital gains tax and long-term capital gains tax. Short-term capital gains refer to gains generated from assets held for less than one year, while long-term capital gains refer to gains generated from assets held for more than one year. The short-term capital gains tax rate is the same as the taxpayer’s ordinary income tax rate; the long-term capital gains tax rate is usually lower than the short-term capital gains tax rate and is divided into three brackets based on the taxpayer’s annual total income and tax filing status, which are 0%, 15%, and 20% respectively.

In addition to the two basic capital gains tax rates mentioned above, the United States also imposes additional surtaxes or provides preferential policies for certain types of capital gains. For example, for high-income individuals (single taxpayers with annual income over $200,000 or married couples filing jointly with annual income over $250,000), they are required to pay a 3.8% net investment income tax.

2 Taxation of Cryptocurrencies in the United States

2.1 IRS Definition of Cryptocurrencies

In 2014, the IRS issued a notice (Notice 2014-21) regarding virtual currency transactions, explaining the treatment of virtual currency for federal income tax purposes. In this notice, all cryptocurrencies are considered property rather than currency, and therefore subject to general tax principles for property transactions. This means that most cryptocurrency transactions are subject to capital gains tax.

The IRS has a broad definition of crypto assets, considering any digital representation of value recorded on a distributed ledger or any similar technology with cryptographic security to be a crypto asset. According to this definition, crypto assets include (but are not limited to) convertible virtual currencies, cryptocurrencies, stablecoins, and non-fungible tokens (NFTs).

2.2 Crypto Asset Transactions Involving Income Tax

According to current IRS regulations, the following crypto asset transactions are subject to income tax and must be taxed according to income tax rules:

• Receiving cryptocurrencies from airdrops

• Cryptocurrency income from DeFi lending

• Cryptocurrency mining income from block rewards and transaction fees

• Obtaining cryptocurrencies from liquidity pools and interest-bearing accounts

• Receiving cryptocurrencies as wages or compensation

If investors acquire new crypto assets through the above methods or through airdrops, hard forks, etc., they generally need to include the fair market value of the assets in their cost basis at the time of acquisition and pay the corresponding income tax.

2.3 Crypto Asset Transactions Involving Capital Gains Tax

Capital gains tax events involving cryptocurrencies include:

• Converting cryptocurrencies to fiat currency

• Gifting cryptocurrencies

• Using cryptocurrencies to purchase goods and services

• Exchanging one crypto asset for another

When conducting crypto asset transactions involving capital gains tax, investors need to subtract the cost basis from the selling price to calculate capital gains or losses and pay the corresponding capital gains tax. As mentioned earlier, the length of time the crypto assets are held (in units of 1 year) determines the capital gains tax rate. If the crypto assets are held for more than 1 year, investors need to pay long-term capital gains tax, which is usually lower than short-term capital gains tax, which applies to holdings of less than 1 year.

The IRS states that crypto investors should specifically identify the assets they dispose of whenever possible. This means that as long as investors can specifically identify the assets they dispose of, they can use cost basis methods within the scope of Spec ID, such as HIFO, LIFO, and FIFO. Once a cost basis method is chosen, it must be consistently used when calculating gains and losses.

2.4 Other Tax Treatments

Regarding minting tokens, the IRS has not yet explicitly stated whether minting tokens (including minting publicly available NFTs or minting interest-bearing assets) would result in taxable events. This is a gray area that remains unresolved and may require future regulations or rulings for clarification. One possible view is that minting tokens is similar to cryptocurrency mining because both involve using computational resources to create new digital assets, and therefore minting tokens may be subject to taxation according to income tax rules.

Regarding DeFi, although there is currently no specific IRS guidance on DeFi transactions, since cryptocurrency staking is considered taxable income in the United States, the profits earned through DeFi platforms are likely to be treated as income from a tax perspective, and therefore subject to income tax rules.

3 Outlook on US Cryptocurrency Taxation

In March of this year, President Biden proposed several cryptocurrency tax reform suggestions in the 2024 federal budget. First, investors with annual incomes exceeding $1 million will see their capital gains tax rate increase from 20% to 39.6%. Second, any company that mines using computational resources (whether owned by the company or leased from others) will be required to pay a consumption tax equivalent to 30% of the electricity cost used for mining. Third, cryptocurrency will eventually be subject to wash sale rules, just like stocks, meaning that investors can no longer avoid taxes through active loss trading. It is expected that this proposal will take effect for tax years beginning after December 31, 2023, but it still needs to go through the approval process.

Prior to this, the Internal Revenue Service (IRS) also issued tax guidance and regulations on some cryptocurrency assets. For example, in October 2022, the IRS issued new guidance (Revenue Ruling 2022-25) on non-fungible tokens (NFTs), clarifying the tax treatment of these tokens. In January of this year, the IRS explicitly stated in a notice that taxpayers should continue to report all digital asset income from the previous tax year. In addition, the IRS is continuously strengthening its supervision and auditing of digital asset traders, requiring them to truthfully report their digital asset transactions when filing taxes and provide corresponding evidence and documentation.

In summary, the US digital asset tax system is an evolving and developing field. With the rapid growth and innovation of the digital asset market, tax authorities and taxpayers need to adapt to new challenges and opportunities. Investors should stay informed and understand the US digital asset tax system, and make reasonable and legal tax planning based on their specific circumstances.

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