Keep it Legal: How to Pay Taxes on Crypto and NFTs
Have you heard the “strange” story of an artist and programmer that goes by the name Shvembldr? His real name is Ilya Borisovs, and he is a citizen of the Republic of Latvia. Instead of being celebrated as one of the most financially successful NFT creators in the world in 2021, he is presently trying hard to get his “normal life” back. What happened to Shvembldr?
Famous NFT artist turned outlaw in Latvia
According to the information on the website he created to tell his story to the world, Ilja Borisovs was declared a money launderer for earning €8.7 million from selling his non-fungible tokens (NFTs). Really? Yes, reportedly! This sad event took place on February 10, 2022, when Latvian police seized all his property, an act he claimed was carried out without prior notice to him. Meanwhile, according to him, his income was transparent, and he paid “all the necessary taxes” to the Latvian government. Will he get his freedom and restoration later? Only time will tell.
The problem is worsened by the fact that there are no unified standards for taxes on cryptocurrencies in the world, but the ideology of cryptocurrencies itself contradicts the circulation of fiat money. The latter is strictly regulated by central banks, and all transfers are traceable (unless we are talking about cash transactions). Cryptocurrencies are anonymous in this respect. On the one hand, blockchain allows you to track how much money has been sent from one wallet to another, but on the other hand, it can be impossible to find out who owns the wallet.
It is this peculiarity of cryptocurrencies that can lead you into trouble. The buyer of the NFT artwork can remain anonymous. He will transfer money to your cryptocurrency account but it won’t be easy to report to the tax authorities about who the money came from. This is the point when anti-money-laundering laws can be applied against you.
What can you do to avoid an embarrassing situation like Ilja’s? In this article, we will show you how to keep things legal when it comes to paying your crypto and NFT taxes.
Do I Have to Pay Taxes on Crypto?
Generally, investors are required to pay taxes on their cryptocurrency gains. This situation is because in most countries where cryptocurrencies have not been banned, crypto assets are not considered a form of payment. Examples of such countries include the United States and the United Kingdom. Instead, they are considered like shares and other valuable property and taxed accordingly.
Tax regulators monitor crypto trading and investments in digital assets. That is why it is necessary for crypto traders and investors to know and understand how cryptocurrency transactions work in relation to taxation in their respective jurisdictions. From basic buying and selling to staking, airdrops, hard forks, and so on, try to know which ones are taxable and pay your government via the right channels.
Is Crypto Tax Avoidable?
Yes, there are some instances in which you can avoid paying tax on your crypto assets. For example, in the UK, you will not pay income tax on airdropped cryptocurrencies if you receive them in exchange for nothing. Nevertheless, if you receive airdrops in exchange for performing a service, they will be taxed as miscellaneous income.
Furthermore, there are other ways to avoid crypto tax. They include using fiat money to buy cryptocurrency, holding your crypto for the long term, making cryptocurrency transfers between your own crypto wallets, and gifting your crypto to a family member or spouse.
Moreover, Self-directed IRAs are special Individual Retirement Accounts you can open in the United States. They allow you to invest in unique assets such as cryptocurrency, precious metals, and real estate. So, you can purchase cryptocurrency as part of retirement, pension, or annuity investment to avoid paying crypto tax.
Crypto Taxes: All You Need to Know
When to Pay Taxes on Crypto
You can pay your crypto taxes to your country’s tax authority at any time. In the United Kingdom, taxes are paid to Her Majesty’s Revenue and Customs (HMRC), while the Internal Revenue Service (IRS) receives federal taxes in the United States of America. European countries also have their own laws regarding cryptocurrencies. Some of them require the declaration of cryptocurrency assets as property or funds in bank accounts and also demand payment of taxes in case of profit from the sale of cryptocurrency. In some countries, it is necessary to pay income tax when exchanging crypto assets for fiat currencies. That is, every time you withdraw funds from a cryptocurrency wallet to your card, you have to pay some money to the government.
Commonly, people pay crypto taxes when:
- Buying and selling crypto: You are likely to pay capital gains tax when you sell crypto above the price you bought it. This tax may also apply to swapping crypto. Besides, in the UK, HMRC will ask you to pay income tax instead of capital gains tax if you are trading huge amounts of cryptocurrencies.
- Paid in cryptocurrency: In most countries, personal income is taxed. Likewise, you are to pay income tax and national insurance contributions when anyone pays you in cryptocurrency.
- They inherited cryptocurrency: Inherited cryptocurrency is recognised as property. For this reason, HMRC requires you to pay inheritance tax when you inherit crypto from someone.
- Mining and validating crypto: If you are doing crypto mining as a business or as a hobby, expect to pay income tax. The additional thing to note here is that if your mining is a hobby, when you are filling out your tax return, declare the income under miscellaneous income.
- Staking: The GBP value of any tokens granted at the time of receipt, according to HMRC, will be taxed as other income, with any reasonable costs decreasing the chargeable amount. You may want to consider it as income from savings and make a personal savings allowance claim to further decrease your tax obligations. If you think about doing this, talk to a tax expert since you could be subject to capital gains tax if you sell it later.
How Much Tax to Pay on Crypto/NFT Gains
The amount you will pay either as income tax or capital gains tax varies by country and, in some cases, by income as well. For example, in the UK, income tax is at different tax brackets, which are 0%, 20%, 40%, and 45% of the profit. A similar system operates in the United States where the income tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Your income tax will be applied to any cryptocurrency earnings.
Those who often buy, sell, or receive cryptocurrency through trading are required to pay income tax. Anyone who actively buys and sells crypto assets in order to generate a short-term profit is known as a "day trader."
On the other hand, capital gains, which apply to profits from investment activities, attract a different tax system. Anyone who purchases, holds, and sells cryptocurrencies on their own behalf is often seen as engaging in investing activity and is therefore liable to pay capital gains tax. The capital gains tax rate for NFTs and other collectibles is also based on the level of income. It could be 28% or up to 37%.
A taxable event will come from selling cryptocurrency, and the value of any earnings will be compared against purchases in the following order: cryptocurrency bought on the same day, cryptocurrency bought during the next 30 days, and the average price of any remaining cryptocurrency (the pool).
In the UK, when an individual's total gains exceed the £12,300 yearly tax-free threshold, they are subject to capital gains tax at rates of 10% up to the basic rate tax band (if applicable) and 20% for gains subject to higher and extra tax rates.
In the USA, for the majority of people, the maximum tax rate on net capital gains is 15%. If your taxable income is less than or equivalent to $40,400 for single filers, $80,800 for married couples filing jointly, or a qualified widow(er), some or all of your net capital gains may be subject to 0% tax.
How to Report Crypto Taxes
The first step to filing your crypto taxes is to calculate the gains or losses you made in cryptocurrency during the trading or investing period. Remember to use the current and appropriate tax brackets when estimating your crypto tax. (We gave you the rates for the UK and the USA earlier in this article.)
Crypto investors and traders in the United Kingdom can report their cryptocurrency taxes to HMRC by filling them in as part of their individual Self Assessment Tax Returns (SA100). As a crypto taxpayer, you must report your cryptocurrency income in the SA100 and use the Self Assessment: Capital Gains Summary (SA108) to report any cryptocurrency capital gains or losses. The filling can be done by post or through the UK Government’s online service.
In the United States, you can file your individual income tax return with the IRS using Form 1040. Before filing it, use Form 8949 to reconcile your sales and other dispositions of capital assets and Schedule D of Form 1040 to record your capital gains and losses. These forms can also be used for NFT gains and losses. Additional information and tools are available on the IRS website to assist you in calculating your crypto-related tax due and how to submit your report.
How Are NFTs Taxed?
There are three ways your non-fungible token investment may be taxed:
- Paying with Ether: A capital gain that can be taxed would occur if an NFT was acquired with a cryptocurrency like Ether (ETH). According to the Internal Revenue Service of the United States, in this kind of transaction, you sold your ETH for fiat and used the money to purchase the NFT, resulting in a taxable event. The price increase between the time you initially purchased your ETH and the time you "sold" it to purchase the NFT will be taxed.
- Having been sold for Ether: A new capital gain taxable event would arise if an NFT was sold for cryptocurrency like ETH or exchanged for another NFT. The IRS interprets this as you selling your NFT for fiat and then repurchasing ETH or another NFT with fiat, the same way they interpret the first occurrence. The increase in ETH's value from the time you originally purchased the NFT and the time you sold it will be taxed to you. Due to the fact that the price of ETH has increased since you purchased your NFT, it is possible that you may have sold your NFT for less than the price of ETH and yet owe taxes.
- Converting back to fiat: When you convert your ETH sales earnings from NFTs back to fiat, the price increase between the time you got your ETH revenues and the conversion's fiat price will be taxed.
Investors in NFTs pay taxes in a different manner than NFT creators do. Selling an NFT in return for cryptocurrency or other payment would result in a taxable event, but producing the NFT would not. A digital collectible created by an NFT artist may be sold for ETH on OpenSea (an NFT exchange), and the proceeds would be subject to ordinary income tax. If the founders in this case do not exchange the ETH for USD at once, a fresh capital gain holding period will start for the ETH they earned from the sale.
Taxes on NFT Airdrops
A token allocation is given out as an airdrop, for instance as part of a marketing or advertising campaign where recipients are chosen at random. Other instances of airdrops include situations where tokens are distributed automatically as a result of the possession of other tokens or in which a participant has registered to be eligible for the airdrop.
According to the 2019 IRS cryptocurrency tax regulations, every cryptocurrency obtained through airdrops is taxable income in the United States. A free cryptocurrency that enters your wallet or exchange account is treated as ordinary income, whether you meant to receive it or not.
Similarly, one of the few areas in which the IRS has given clear instructions is the taxation of airdropped tokens, which are to be treated as ordinary income. The amount of this revenue is equal to the USD value of the airdropped coins or NFTs at the moment of reaching the wallet.
In the United Kingdom, HMRC approaches the issue quite differently. Tokens that were airdropped and were obtained in a personal capacity are sometimes exempt from income tax. If they are obtained in an unrelated manner (for example, not in exchange for any services or other conditions), or if they are not connected with any trade or operation involving mining or crypto asset exchange tokens, income tax may not be applicable.
Additionally, airdrops that are given in exchange for services or in anticipation of receiving them are liable to income tax as either miscellaneous income or profits from an active business. Moreover, even though a token obtained through an airdrop is not initially subject to income tax, selling it may result in a gain that is subject to capital gains tax.
Will I Pay Taxes on NFTs that I’m Gifted?
Probably not! The act of receiving a gift is usually not subjected to taxation. But if the amount is higher than $16,000, the donor will most likely need to pay "gift tax" in the United States. He or she must then submit IRS Form 709.
Nonetheless, you will have to pay capital gains tax if you sell the cryptocurrency you received as a gift for a profit. In that case, your cost basis will be the price the original buyer paid.
NFT Taxes for Investors
Investors will pay taxes when they use crypto to purchase NFTs. In this instance, they are liable to pay capital gains taxes on the increase in the value of the cryptocurrency used in buying the NFTs. For example, if you paid the equivalent of $500,000 for a Happy Ape on OpenSea using 100 ETH, but had initially bought the ETH for $1,000 per unit, you would be required to pay capital gains tax on the difference of $400,000 (=$500,000 - $100,000) on the increase in ETH's value.
Also, selling an NFT on a marketplace, such as OpenSea, will require you to pay capital gains tax on your income from any increase in the value of the NFT. The length of time you owned the asset determines your tax rate; if you kept it for a year or less, you would pay short-term rates. You would get the advantageous long-term rates if you kept it for more than a year.
NFT Taxes for Creators
Creators or artists are not required to pay taxes for minting NFTs. But creators will be taxed on the income made from selling their NFTs. However, there is currently no tax guidance regarding NFT royalty income. As an alternative, you can report a one-off sale that generates royalties as passive income.
Is Donating an NFT Taxable?
Artists and investors are increasingly giving NFTs to museums or auctioning them off to benefit charities. A donation of an NFT is not taxable. Also, giving an NFT can reduce gross income if certain conditions are satisfied, such as the NFT being older than a year and the donation being made directly to the charity.
However, because U.S. tax law currently allows cash gifts of up to 100% of adjusted gross income (AGI), a donor may convert NFT earnings into cash and donate an amount large enough to cover their entire tax obligation.
Play-to-Earn (P2E) Gaming Taxes
Characters, tools, scenery, and other in-game assets may now be held by players and exchanged for other asset types thanks to a brand-new category of online gaming that Web3 has established. These games are frequently referred to as "play-to-earn" (P2E) since players can make money through competing and reproducing (that is, trading NFTs or other crypto assets).
The main lesson to be learned from each game's mechanics is that because the majority of activities in a play-to-earn game involve crypto-to-crypto exchanges, they will almost always be taxed. While gaining in-game assets through network activities would probably be considered income, selling an in-game item for a profit would be a capital gain event.
Yes! Ordinary income tax is due to the profits that artists and creators realise from selling NFTs. Also, where some NFTs are seen as “collectibles," the investors who make gains from holding them for more than a year are subject to capital gains tax.
Generally, NFT airdrops are subject to ordinary income tax at the current market value. The receiver is to pay the tax as a percentage to the tax agency. This is basically what to expect in several jurisdictions, including the United Kingdom and the United States.
As an individual investor, you can report your NFT gains to the IRS using Form 1040 (Income Tax Return) and Schedule D of this form for Capital Gains and Losses. Before filing it, use Form 8949 to reconcile your Sales and other Disposition of Capital Assets.
NFT creators are to report their income from NFTs according to their various filing statuses:
- Self-employed creators are to use Schedule C and Schedule SE to report Profit or Loss From Business and Self Employment Tax, respectively.
- C Corporations are to use Form 1120 for US Corporation Income Tax Return.
- S Corporations are to file Form 1120S to report their US Income Tax Return for an S Corporation.
- Partnerships are to use Form 1065 to report their US Return of Partnership Income.
To assist you in calculating your tax due and how to submit your report, use the additional information and tools on the IRS website.
The first step in paying your crypto taxes is to determine your cryptocurrency gains or losses throughout the period. When calculating your crypto tax, keep in mind to use the most recent and suitable tax brackets in your jurisdiction. (In this post, we offered rates for the United Kingdom and the United States.)
Crypto investors and traders in the United Kingdom can report their cryptocurrency taxes to HMRC by filing them as part of their individual Self Assessment Tax Returns (SA100). While in the United States, you can file your individual income tax return with the IRS using Form 1040.
You can avoid paying crypto taxes by:
- Using fiat money to buy cryptocurrency.
- Holding your crypto for the long term.
- Making cryptocurrency transfers between your own crypto wallets.
- Gifting your crypto to a family member or spouse.
- Purchase cryptocurrency as part of retirement, pension, or annuity investment.
If you HODL your crypto and do nothing, you will not pay any tax because there is no event that produces a profit for you. It is when you sell the cryptocurrency and receive another crypto or cash in return that you will have to pay tax on your gain.
Best Payment Services That Support NFTs
Binance has an exchange for buying and selling non-fungible tokens. It is called the Binance NFT Marketplace. Creators and investors can use this platform to make money from in-game assets, artwork, and other digital collectibles. It charges a transaction fee of 1%.
You can use any self-custodial crypto wallet to find and follow NFT creators on the Coinbase NFT marketplace. It is powered by web3 and does not require the use of a username and password. The Coinbase NFT exchange is temporarily accessible for free until further notice of a transaction fee.
Buy, sell, and trade NFTs on ZenGo. It is a simple wallet for crypto, non-fungible tokens and DeFi Dapps. You can use this service to connect your blockchain wallet to NFT marketplaces, including OpenSea. ZenGo provides 3D biometric encryption and 3-factor authentication for advanced security.
Stipe now offers flexible APIs for crypto and NFT transactions via its robust payment gateway. Advanced fraud protection and know-your-customer services are also available to the users of Stripe’s crypto solution.
BitPay is a smart crypto platform where you can sell your NFT. It has a massive crypto audience for you to grow your business. BitPay charges a transaction fee of 1%. Eight different cryptocurrencies and 100 crypto wallets are supported on this platform.
Income taxes and capital gains taxes apply to cryptocurrencies and non-fungible tokens in different jurisdictions. There are several circumstances in which you may or may not pay taxes. In this article, we used examples from the United States and the United Kingdom to answer questions about clearing your taxes on crypto and NFTs. We hope that you have learnt how to safely make money from trading and investing in digital assets without getting outlawed.