Income classification [Updated 2020]

Categorize the incoming digital assets and report them appropriately on your taxes

Reporting income in cryptocurrency is required by the IRS according to the new guidelines provided. Also, the clarification is provided on various modes of receiving such digital assets. Income taxes on cryptocurrency incoming transactions can be calculated easily and smartly using BearTax.

Our intelligent system can identify your transfers between the exchanges and lists down the remaining unidentified deposits for your review. This step is very helpful for you to classify each of these deposits into various categories.

Supported Incoming sources of cryptocurrency

Incoming transactions should be classified in various categories and each of them could be treated differently depending on the date of the transaction as well as the purpose of the transaction. We provide an exhaustive list for the users to classify their incoming transactions.

  • Gifts
  • Staking rewards
  • Airdrops
  • Hard forks
  • Referrals
  • Mining
  • Voting Rewards
  • Community Rewards
  • Inheritance
  • Earning programs
  • Paid in Crypto

Cryptocurrency received as a Gift

Your basis in virtual currency received as a bona fide gift differs depending on whether you will have a gain or a loss when you sell or dispose of it. For purposes of determining whether you have a gain, your basis is equal to the donor’s basis, plus any gift tax the donor paid on the gift. For purposes of determining whether you have a loss, your basis is equal to the lesser of the donor’s basis or the fair market value of the virtual currency at the time you received the gift. If you do not have any documentation to substantiate the donor’s basis, then your basis is zero.

Cryptocurrency earned in Staking rewards

Certain cryptocurrencies, by their definition, are generated by holders holding certain amounts of existing assets. This is called staking. You hold a certain amount of cryptocurrency in a contract and earn a part of it as a reward.

These are called staking rewards and income tax rules are applicable for the crypto earned via staking. Cost basis is applicable depending on when the asset hits your wallet or account

Cryptocurrency Airdropped to you

In certain cases, to increase the adoption of a certain blockchain's applications, that particular blockchain's tokens will be distributed for free depending on various criteria. This is called as airdropping tokens. This helps to create initial traction and network effects from early users.

Taxes on cryptocurrency airdropped into your account or wallets will be considered as income. The cost basis will be define as the price of the coin when the transaction is recorded on the distributed ledger, provided you have dominion and control over the cryptocurrency so that you can transfer, sell, exchange, or otherwise dispose of the cryptocurrency.

Cryptocurrency earned as part of a hard fork

A fork is a software term to depict a split of the underlying code and thus the system's functionality. This happens when 2 or more parties disagree on something and want to take the software in 2 different directions. There could be a soft fork and a hard fork. Softfork is when the majority accepts and moves onto a new code and the old one becomes obsolete. Hardfork is when both branches have good support and split into 2 different functional systems. In such a case, a user holding tokens of initial software will end up holding equal amounts of tokens on both the new systems. So, the new value would be different and you hold 2 tokens instead of one.

There is no income generated out of a soft fork and hence there is no income tax for that event. A soft fork occurs when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency.

There is a tax implication when a hard fork occurs. When you receive a new cryptocurrency as mentioned above, you will have taxable income in the taxable year you receive that cryptocurrency. This is considered an ordinary income equal to the fair market value of the new cryptocurrency when it is received, which is when the transaction is recorded on the distributed ledger.

Cryptocurrency earned via referral & affiliate programs

Referral programs are where users are encouraged to share the software they use and love with their friends and family. The company owning the software pays out incentives to its users for bringing in new customers. These incentives are often paid in cryptocurrency (a common one or the token owned by the software like an exchange token etc.,)

Taxes on cryptocurrency received as a referral bonus: If you receive cryptocurrency in a transaction facilitated by a cryptocurrency exchange, the value of the cryptocurrency is the amount that is recorded by the cryptocurrency exchange for that transaction in U.S. dollars. Cost basis is the value for which it was trading on an exchange at the time you received it.

Cryptocurrency mined by individuals

Cryptocurrency or the digital assets are aimed to be decentralized and the transactions on the blockchain need to be validated by various participants of the network. Incentives for participants to validate such transactions are the rewards they get out of every successful block they validate. This decentralized validation is called cryptocurrency mining and the rewards paid for each validation are called mining rewards. These mining rewards are taxable and the need to be declared as income depending on the date and time it was deposited to your wallet. Cost basis is also defined by the same timestamp

Cryptocurrency earned through voting rewards

Similar to airdropping to gain initial traction for the platform, exchanges have found a way to get some initial volume for trading as well as platforms are ready to give away initial tokens for the adoption. This works out win-win for both parties and users are interested in earning some free money. So, there will be voting on which platform to be listed on an exchange and users get to choose one depending on their interest and viability of the project. Winning voters get tokens distributed and these are called voting rewards. This is considered as income and could be treated similar to airdropped coins.

Cryptocurrency earned as community rewards

There will be initial adopters and also initial employees who work to build a community for a cryptocurrency project to be successful and gain a value of its own. Those who build and engage the community around the project are called community managers. These community managers are often paid in the tokens of the blockchain project. These are called community rewards. These tokens need to be reported as income as they are been paid in a cryptocurrency and the cost basis for these rewards is the date when they are received.

Cryptocurrency earned via Inheritance

As the generation passes on and the adoption increases, some of the older generations could pass it on to the next generation. These could be either gifts or inheritance digital money passing along. Accountants and the IRS needs to provide more clear guidance on this. It is important to mention the category while classifying your income as it helps you amend it in future if something changes or the IRS provides much clear guidance on this.

Cryptocurrency earned for completing tasks/education

Major platforms like Coinbase earn lets users earn certain cryptocurrency by learning about it. It is like completing a few online lessons or performing some tasks on their platform and the user can earn few tokens worth about $10 to $50. This is also considered a method to gain initial users as well as to educate more people about the platform and reward them for being initial customers. These rewards would be treated similar to airdropped coins with a cost basis as the date and time of deposit of those tokens to users’ wallets.

Cryptocurrency received for a service a.k.a Paid in cryptocurrency

Freelancers and full-time employees work for employers ranging from startups to enterprises in financial technology space dealing with cryptocurrency. It could either be within their country or a remote assignment for an employer in a foreign country. Getting paid in cryptocurrency is normal for these new-age employees. This kind of earning should be reported as an income on your taxes with the cost basis as the date on which the income was paid.

Taxes on cryptocurrency earned by getting paid in cryptocurrency would vary depending on the income bracket an individual is in and various other factors. Self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.

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