If you earn income through cryptocurrency mining, staking, interest or trading, you might have to pay quarterly taxes (also known as estimated taxes) to the IRS and state to avoid underpayment penalties.
The US has a pay-as-you-go tax system. This means you are required to pay taxes on income as you earn them and not at the end of the year. This is the reason why a portion of your weekly or bi-weekly paycheck goes towards income taxes. Income tax withholding is done by your employer.
However, income tax is not automatically withheld for income streams like mining, staking, interest or cryptocurrency capital gains because there’s no withholding agent like an employer. In these cases, you are responsible for calculating the correct quarterly tax amount and pay to the IRS and the state.
If you expect to owe $1,000 or more when you file the return, you are required to submit quarterly tax payments for the income earned You can pay your estimated taxes using Form 1040-ES and mailing a check to the IRS or at the IRS website.
You can use page 8 of Form 1040-ES instructions to calculate your estimated taxes. However, if you have a large amount of income coming from multiple non-income tax withheld sources (Crypto trading, rental income, business income, etc) it is highly recommended to use a qualified accountant to calculate the correct estimated tax amount.
Whenever you incur a taxable event from your crypto investing activity, you incur a tax reporting requirement.
A taxable event simply refers to a scenario in which you trigger or realize income. As seen in the IRS virtual currency guidance, the following are all considered taxable events for cryptocurrency:
In certain circumstances, you will not trigger any taxable events when transacting with crypto, and you will not have to pay or report any cryptocurrency taxes.
You do not trigger a taxable event when you:
If you didn’t have any taxable transactions, you generally don’t have any cryptocurrency specific filing requirement. However, some non-taxable transactions may trigger you to check “Yes” on the virtual currency question on Form 1040 ‒ “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
Once you have all the transaction data, you can use a cryptocurrency tax software to reconcile your transfers, trades and other transactions to arrive at capital gains (or loss) and other income you need to pay taxes on. Without this reconciliation, you could be underpaying or overpaying taxes.
(Note that cryptocurrency tax software don’t generally file your taxes with the IRS. They only reconcile the capital gains and losses related to crypto activity)
If you don’t pay quarterly taxes, you will have to pay an underpayment penalty when filing your tax return in the following year. The underpayment penalty is calculated on IRS Form 2210. You can avoid this penalty if you owe less than $1,000 in tax after subtracting your withholdings and credits, or if you paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller (Safe harbor calculation).
For example, Jennet was a full time employee during 2020 who earned $40,000 in annual salary. Her tax liability was $10,000 according to her 2020 Form 1040 Line 24. On January 1, 2021 she decided to quit her job and sell some of her bitcoins. As a result, she made $60,000 in capital gains in 2021 Q1. To meet the safe harbor and avoid an underpayment penalty, she has to pay at least $9,000 (90% * $10,000) of quarterly taxes by April 15, 2021.
Taxes aren’t the first thing most investors consider when jumping into the world of bitcoin and cryptocurrencies. However, as the IRS continues to crack down on crypto tax compliance, it’s becoming increasingly important to learn about how cryptocurrencies are taxed.