With its highly liquid market and wild price actions, it should be no surprise as to why cryptocurrencies have become popular with investors. However, as with any other form of income, any income derived from or transacted using cryptocurrencies and other digital assets are taxable by the IRS - even if you’re an American ex-pat living overseas.
Since cryptocurrencies are a relatively new-fangled concept, settling taxes can get complicated especially if you’re not privy to the nuances of American tax law. Compound that with living overseas, then you get a situation where Americans working abroad are opting to skip filing taxes for expats rather than going through the quagmire of tax compliance. However, this is ill-advised as the IRS has aggressive measures in place to track these types of financial activities and can land you in legal hot water when caught.
If you’re an expat who has transacted using cryptos or owns any other form of digital assets, it’s important that you’re aware of how to disclose these activities to the IRS.
Whether you have profited from your crypto transactions or are in possession of Bitcoin and Ethereum, or any other kinds of digital assets like non-fungible tokens (NFTs), you’ll have to disclose them to the IRS and make them a part of your expat tax return.
In 2014, the IRS released Notice 2014-21 to address the questions surrounding the tax situation of cryptos. In it, the agency stated that all cryptocurrencies will not be treated as currencies, but as assets that are similar to properties. As such, the tax principles that are applied to property transactions also apply to transactions involving cryptos and other digital assets.
With that said, how these crypto transactions are disclosed to the IRS is largely determined by the nature of the transaction. You can lump these transactions together into three general categories:
a way to send or transfer money
a way to receive money
an investment vehicle
We’ll discuss each category in turn.
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Context is important to determine the method of reporting this activity; did you receive the cryptocurrencies as a gift, or was it a form of payment for something you’ve sold? This distinction is important as these activities are treated differently.
Crypto that is received as payment will be counted as business income. Therefore, you should report this as revenue on your business income tax return.
Meanwhile, the amount of the cryptocurrency that is received as a gift is not taxable. However, you’ll need to report the capital gain from the conversion of the cryptocurrency into fiat money or when you spend it. Since crypto prices are changing by the second, then you’ll have to report it as a capital gain or loss on the day of conversion.
Moreover, if the cryptocurrency was gifted by a foreign national, you’ll have to report this transaction, but the amount is non-taxable, too.
How American expats should report sent or transferred cryptocurrency and cryptocurrency as an investment. Again, you will have to specify whether the transaction counts as a gift or payment for something you bought.
Declare gifted cryptocurrency as a gift tax return (Form 709) if the value of the gift given to any one person within a fiscal year is at least $15,000.
For cryptocurrency used as a mode of payment, use Schedule D and Form 8949 for capital gain. You need to calculate the financial gain or loss triggered by the transaction to know its corresponding tax obligation.
Since cryptocurrencies are treated as capital asset by the IRS, only the gains from the sale are taxable. Hence, you won’t need to report your crypto portfolio to the IRS until you’ve sold your positions. You can declare these transactions via Form 8949.
Cryptocurrency Tax Exclusion
Yes, there are instances where you may be legally allowed to exclude cryptocurrency assets from your tax return. Through the Foreign Earned Income Exclusion (FEIE), there’s a possibility for exemption. One FEIE acknowledged scenario is when you earn wages or business income in cryptocurrency from a foreign employer or client.
However, you will still have to declare capital gain on your received cryptocurrency wage or income, based on the asset’s current value versus original value upon receipt.
Cryptocurrency and the Foreign Account Tax Compliance Act (FATCA)
Under FATCA, all US citizens and legal residents must declare overall financial holdings in their yearly returns. The law covers cryptocurrencies, which are treated similarly to properties, and as such are considered as assets.
FATCA declaration is made through the Statement of Specified Foreign Financial Assets (Form 8938). Here, there’s a reporting threshold you need to know based on your marital status. Unmarried taxpayers adhere to a threshold value of $200,000 at the end of the year or $300,000 at any point within the fiscal year. That means if your foreign financial assets reach those values, you need to accomplish Form 8939. For married taxpayers filing a joint return, those thresholds double.
Cryptocurrency and the Report of Foreign Bank and Financial Accounts (FBAR)
The FBAR requires U.S. citizens and legal residents living abroad who own foreign accounts totaling $10,000 at any point within the fiscal year to file a report with the Financial Crimes Enforcement Network (FinCEN) using Form 114.
As of the moment, FBAR laws don’t officially cover cryptocurrency assets. That’s because the IRS considers them as property instead of cash. However, tax experts advise including cryptocurrency assets in FBAR declarations anyway. That is given how mandates governing cryptocurrency may quickly change and it’s best if you’re ahead of these changes.
The Amnesty Program
If you have failed to file your returns for consecutive years, do not worry. There’s recourse for your mishap via an amnesty program called the Streamlined Procedure. The process allows you to catch up on your tax payments without incurring penalties if you can prove that your non-compliance wasn’t willful.
The IRS might even waive any penalties associated with failure to file FBAR. Again, that is if there’s a reasonable cause for the oversight.
Crypto Tax Tips
In recent tax return forms, there’s the addition of a very specific tax question. Did you engage in virtual currency transactions during the year? If you answered yes to that question, here are tax tips you should take to heart.
1. Keep a record of all crypto transactions
The IRS requires supporting documents for every claim you make on your return. So be ready with receipts. Make it a habit to secure all records about the prices of cryptocurrency you buy or sell, as well as those you receive or send as a gift.
2. Use relevant software
You’re in cryptocurrency. You’re likely tech-savvy. So don’t complicate recordkeeping by doing it manually. Get help from reliable software. Consider tools like Cointracker and Koinly. They’ll help you track every crypto payment you make and consolidate necessary documents for your tax compliance.
3. Learn how to offset
Treat cryptocurrency the way you treat other fixed assets. Learn how to offset gains with incurred losses. For example, if your Ethereum cache dipped in value by $3,000 and your Bitcoin assets appreciated with the same value, make the IRS know you broke even. It’s not cheating. It’s being clever.
4. Trade strategically
Tax rates fluctuate. If you’re not under financial stress, try to schedule your crypto trading when rates are low. That way, should you profit off selling cryptocurrency, your tax obligations won’t hinder you from enjoying your capital gain.
5. Claim for mining expenses
Cryptocurrency mining is part and parcel of crypto investment. It only follows that the IRS acknowledges the expenses linked to the process. Maximize this opportunity by claiming expenses for mining activities. Those expenses may cover computer maintenance and repair, electric bills, and software purchases, among others.
6. Familiarize yourself with relevant tax forms
Make a list of the tax forms you need every year. Familiarize how they look. Before Tax Day, check if there are any changes in them. Refer to this list:
FinCen Form 114
7. Hire a professional
Simplify tax filing by working with a professional, regardless of where you reside. You can communicate with a hired accountant on U.S. soil to help you with tax matters. So, trust an expert with your taxes and be spared from tax-related stress.
Every U.S. citizen must file returns and pay due taxes. That holds even if you’ve chosen to reside outside of American soil. Moreover, this financial responsibility extends to non-traditional assets, such as cryptocurrencies. So, if you’re an expat with digital currencies in your financial portfolio, you must declare those in your tax returns to prevent the IRS from breathing down your neck.
Otherwise, there’s a high price to pay for negligence and tax non-compliance. For instance, failure to file an FBAR can cost as much as $100,000 or 50% of outstanding foreign accounts. For non-wilful violations, penalties may be reduced to $10,000.
Either way, those are significant amounts of money you don’t want to go kaput just because the IRS did not receive the pertinent tax documents, they expect from you on Tax Day.
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***Note for U.S. citizens: US citizens are limited in their tax reduction possibilities due to FATCA and CFC laws. Opening an offshore company can increase privacy and asset protection, but you can not eliminate your taxes without giving up your citizenship. If you are a US citizen you are obligated to pay taxes on all worldwide income. Read more here about FATCA and CFC laws.