Selling crypto can of course raise taxes, but even buying something with crypto – a house, a car, a new suit – can raise taxes. Even paying taxes in crypto can trigger taxes. The tax paradox began when the IRS ruled in the 2014-21 Notice that cryptocurrency is owned. This classification has some serious tax consequences that are compounded by wild price fluctuations. If you pay off $ 5,000 in crypto debt while the crypto is worth $ 5,000 when you pay it off, you’re home free, right? Not really. You need to take into account the sale you just made. Transferring the crypto to pay off your debt is a sale, and that could mean more tax for the year of payment. If you bought the crypto for $ 5,000 the day you pay the debt, there is no profit. But if you don’t pay off a debt but buy something, it’s worse.
Paying employees or independent contractors in crypto will result in taxes if they receive it. And if you pay them, you too could suffer a tax collapse since you just sold your crypto on your side of the equation. When paying with crypto, keep in mind that most crypto transfers are taxable unless the transfer is considered a gift or a charitable donation. We get to that, but first, what about transfers to legal entities?
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Transfers to Controlled Companies. How about putting your cryptocurrency into a company or partnership that you will control? In general, the transfer of ownership to a corporation in exchange for its shares is a taxable event. It is as if you sold the property to the company for cash. The difference between the share value you received and the tax base of the assets you transferred to the company will result in a gain or loss. However, Section 351 of the Tax Code basically allows property to be transferred to a corporation in return for shares without triggering taxes, even if property is valued. The corporation can either be an S corporation (generally taxed as flow-through) or a C corporation (which pays taxes itself). Society can be reorganized or pre-existing. Of course, there are some requirements to be met, but if you do, some profits from exchanging property for shares may be delayed. The IRS can tax it later if the shareholder eventually sells the shares received on the stock exchange.
There will be no profit or loss as long as you only receive shares in exchange for your property and you are in control of the company immediately after the exchange. Control means holding shares that hold at least 80 percent of the total voting rights of all voting share classes and at least 80 percent of the total number of outstanding shares of all other classes of shares in the company. If you are moving property into a corporation with others, you can do so as a group. So you don’t need to be in personal control.
The same can work for a partnership or LLC. Contributions of property or money in exchange for equity interests are usually non-recognition events. Similar to corporations, the contributions can be tax-free for both the contributing shareholder and the partnership. For partnerships, this non-recognition rule is contained in Section 721 (a) of the Tax Code. In principle, it applies regardless of whether the contribution is made when the company is founded or after a longer period of existence and activity. But there are some potential pitfalls, more with partnerships than companies.
This non-recognition rule does not apply, for example, to transactions between the partnership and a partner who is acting outside of his capacity as partner, or if the alleged contribution is a disguised sale. In addition, pursuant to Section 721 (b), the non-tax rule does not apply to gains realized on a contribution of assets to a partnership “investment company” if the contribution leads to a diversification of the transferor’s assets. All of these problems that taxes can trigger can be difficult to spot.
gifts. You can give away crypto and no income taxes will be raised. That’s right, no income tax for you as a donor and no income tax for the recipient. If the recipient transfers or sells it, then of course income taxes will apply. And at this point the recipient would have to calculate profit or loss. What is its tax base since it is a gift? The tax base is the same that you had on the gift. However, remember that a gift really has to be a gift to avoid income taxes. The tax law is littered with cases of people claiming something was a gift but getting stuck on income tax. Since gifts are not subject to income tax, it can be tempting to characterize money or property given as a gift. But be careful: the IRS hears this “it was a gift” excuse a lot. And the IRS is unlikely to be convinced unless you can document it. In addition, the IRS normally expects a gift to be given in a normal gift-like setting. For example, if an employer or former employer gives a loyal employee $ 10,000, is that a gift? No, it is a bonus that is treated as a reward. Even trying to document it as a gift cannot change that result.
True gifts cannot trigger income tax, but gift taxes may apply. When giving crypto to a friend or family member – really everyone – they are asking how much it is worth. If the gift is worth more than $ 15,000, you’ll need to file a gift tax return. For 2021, $ 15,000 is the “annual exclusion” amount. Up to this amount, you can give gifts to any number of people each year without the need to report. A gift tax return is required on all gifts in excess of this $ 15,000, although you may not be required to pay gift tax. Instead of paying gift tax, you would typically use up a small portion of your lifetime exclusion from gift and inheritance tax.
Donation. What if your gift is donated to a charity rather than a person? If you donate to charity, it can be very tax-friendly from an income tax point of view. Typically, when giving crypto to a qualified charity, you should receive an income tax deduction for the full market value of the crypto. If you bought it for $ 500 and you donate it to a 501 (c) (3) charity when it’s worth $ 15,000, you should receive a $ 15,000 charity deduction. Additionally, there is no capital gains or income tax to pay on the $ 14,500 spread. That’s a good deal. It is for this reason that most savvy people – think Warren Buffett – would rather donate valuable property than money to charity. Remember, if you are using crypto to buy something, the IRS will consider it to be selling your crypto. You have to calculate profit or loss. You may have bought something with your crypto. But you made a sale in the process. Be careful, the IRS is still looking for taxpayers who don’t pay taxes on crypto.