I think everyone already knows, The tax office is aware of your crypto-secured coins and wants a share of your profits.
We know this time of year can be especially stressful for crypto natives, considering it's tax season in many countries around the world. In this article, he will focus on IRS regulations as the US personal filing deadline approaches. However, given that many tax authorities treat cryptocurrencies in a similar manner, this is still relevant to everyone.
Towards the end of 2023, the new meta was very evident. air drop farming. Let's take a look at the pitfalls of airdrop taxes, how to file cryptocurrency taxes, and some tips to avoid tax from the tax office. 👇
Editor's note: With the April 15 deadline fast approaching, we reached out to Patrick McGimpsey of Crypto Tax Calculator and asked him to create a primer on paying your Airdrop taxes. This is not sponsored content.
Basics of virtual currency tax
There are two main types of taxes to be aware of when investing in cryptocurrencies: capital gains tax (CGT) and income tax. For clarity, a CGT event occurs when you dispose of your crypto assets, and an income tax event occurs when you earn a profit in a manner similar to income.
Here is a basic list of some events that fall into each category.
đź’¸Capital gains tax
- Profits from selling cryptocurrencies
- Profit from exchanging cryptocurrencies (e.g. selling BTC for ETH)
- Purchasing goods or services using cryptocurrency
- Profits from NFT trading
đź’ŞIncome tax
- air drop
- staking reward
- hard fork
- DeFi/Farming Rewards
- mining
- Salaries are paid in cryptocurrencies
Considering the number of airdrops over the past 12 months, we will specifically focus on the treatment of taxes on airdrop farming and airdrops themselves.
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Tax implications of airdrop farming
If you are practicing airdropping across different protocols and chains, it is important to understand the tax implications of your activities.
Although the IRS has not issued specific guidance on many of the sensitive virtual currency transactions that exist, there is enough information available to speculate on how to treat certain scenarios for tax purposes. .
During your travels, you've likely deposited your cryptocurrencies into at least one smart contract for purposes such as staking, farming, or providing liquidity. No matter what you do, it's important to know that the IRS may treat this as a disposition event and trigger a capital gains tax event.
There is no specific guidance regarding smart contract deposits, but the issue comes down to beneficial ownership. If you lose control of your tokens after they are deposited, the IRS may claim this is a decommissioning event.
Consider the following scenario.
Susan, an avid airdrop farmer, decided to stake 10 ETH on the staking protocol. She originally purchased ETH with her $20,000, but the market value at the time of her deposit was $25,000.
Susan considers whether she maintained beneficial ownership of her ETH during the deposit and believes she did not. Therefore, she treats her deposit as a disposal, giving rise to a capital gain of $5,000.
In the absence of specific guidance, there are usually two options. You can take a conservative policy and avoid penalties, or you can take a more aggressive stance and risk reapplying and potentially paying penalties in the future.
If you adopt a more aggressive stance, you will need a rationale to support your argument. We strongly recommend that you consult a tax professional before proceeding with this method.
It is important to remember that many smart contracts also provide receipts or LP tokens in exchange for a deposit. The IRS has clear guidance that trading between virtual currencies triggers his CGT event, so if you find yourself in this situation, you may have a hard time adopting a different approach.
If you are one of the many people who have experienced hundreds or even thousands of smart contract interactions through airdrop farming, you may be thinking about the accounting nightmare you are having. yeah. Don't stress. We've put together a few options below to help you get your taxes organized at night without worry.
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How are airdrops taxed?
Leaving aside the actual farming activities, let's take a look at the airdrop itself. The important thing about airdrops is that the IRS considers them taxable income at the market value at the time they are received.
Continuation of the above scenario:
The protocol that Susan used to stake ETH decided to reward its users and she was eligible to claim 1000 tokens. Susan accessed the airdrop portal and claimed the tokens once she received them in her wallet. The market value of the token was $15,000.
In this situation, the IRS considers Susan to have earned $15,000.
Susan decides to hang on to the token, but the value of the token gradually declines. Eventually, Susan decided to cut her losses and sold the tokens for $5,000 in the same fiscal year.
In this case, Suzan triggered a CGT event and accumulated a loss of $10,000. This is calculated by subtracting the sale proceeds from the value at the time Susan first received the tokens in her wallet.
Susan did not engage in any further cryptocurrency activity for the remainder of the financial year. With her $5,000 gain from her staking deposit and her $10,000 loss from airdropping her token sale, she ended her year with a net capital loss of $5,000.
Hidden pitfalls of airdrop farming
Even though she incurred a capital loss of $5,000 and took home only $5,000, Susan still has to pay taxes on her $12,000 of income. What should I do?
The IRS only allows Susan to deduct $3,000 worth of capital losses from her income each fiscal year. This put Susan in the position of having to pay taxes on $12,000 of income, even though she only deposited $5,000 from the airdropped tokens.
This is the hidden pitfall of airdrop farming (and many other crypto activities that generate income). If Susan had received a larger airdrop, or if the token had fallen further, things could have gotten even more out of control.
In some situations, investors may end up paying more taxes than the value of their entire portfolio. When it comes to airdrops and other crypto income, always make sure you have enough funds to cover your taxes right away to avoid this situation.
Avoid the crypto tax nightmare
Cryptocurrency taxes can be a maze at the best of times, but if you're actively airdrop farming, it can become a nightmare if you're not well-equipped.
It is common for crypto natives to have multiple exchange accounts and potentially hundreds of wallets across numerous new chains. Records of all transactions are required for tax purposes. Otherwise, the numbers may not add up and you may end up paying too much tax.
You have several options. One way is to manually calculate your taxes yourself. This is probably best if you just want to track some basic buys and sells across one or two exchanges. On the other hand, you may also consider consulting a tax expert. If you have a complex stock holding and need to discuss where to start, this may be your best option.
If you have fallen down the DeFi or NFT rabbit hole and have participated in airdrop farming using software such as: Virtual currency tax calculation tool Probably that's your best bet (I work here!Use code BANK30 to get 30% off your first year). With the right crypto tax software, you can sync your various wallets and exchange accounts and automatically generate pre-filled tax forms.
Calculating taxes with cryptocurrencies can be daunting, but don't put it off or set yourself up for trouble down the road. actively. You have this!
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