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Tax on Crypto Interest: How Does it Work?

Crypto platforms provide different investment options that help you earn crypto interest. Since the earnings add to your income, they are subject to tax. Depending on how you earned the crypto interest, this could be either an income or capital gains tax.

Introduction

Cryptocurrencies take investing to another level. They make it easy to earn passive income and have garnered much interest as a result. Still, many crypto investors do not know how to report taxes on crypto transactions. You may have the same problem.

Keep in mind that you must pay taxes if you usually earn interest from crypto investments. There are exceptions to this rule, though, and we will cover them all in today's article. Keep reading to learn more.

Understanding Cryptocurrency and Taxes

Cryptocurrencies have always been a mystery to many people, including governments. Many governments are now trying to understand how they work. Some see crypto as the enemy, though, and ban it altogether. They usually do this because many people turn to crypto, making it hard to tax their transactions. On the other hand, some who have embraced it have developed tax rules in a bid to regulate it.

Take the IRS, for example. It does not directly tax crypto but provides general guidelines for crypto transactions. Also, President Biden's new bill is bound to introduce more tax regulation to the crypto space. This bill requires all crypto parties to provide tax information to both the users and the IRS. It goes into effect on January 2024.

What Is Crypto Interest?

This is the income you get when you deposit your crypto in interest-earning platforms. It also involves passive income from other crypto investments, such as lending. You can earn this interest on the same digital asset you invested in or a different one, such as stablecoins.

Is Crypto Interest Taxable?

Most countries, including the US, consider cryptocurrencies as property. Thus, any interest from crypto investments qualifies for taxes. How much tax you pay depends on the FMV (Fair Market Value) of the earned digital asset at the time of earning.

Furthermore, crypto earnings boost your monthly or yearly income. So, the more you earn, the more tax you'll pay.

Crypto interest taxes usually fall into two groups:

Ordinary Income Tax

This is the tax you owe the Government for earning crypto as income. It comes into play if you stake, mine, or earn crypto in any form. The government calculates your taxable income based on the assets' FMV.

Capital Gains Tax

Your capital gain or loss is the difference between the purchase and sale value of your crypto asset. You must pay capital gains tax on the profit if you made a gain. Losses, on the other hand, are deductible from your taxable income.

Buying and hodling (holding) crypto does not attract taxes, though. The same rule applies even if the held asset increases in value during the period. An asset only qualifies for tax if you sell it.

Other non-taxable events to remember include:

  • Donating digital assets to a tax-exempt non-profit or charity. But, the organization must be tax-exempt.

  • Receiving a crypto gift. If someone gifts you crypto, you don't need to file any tax return. Still, you must pay taxes if you sell the received assets or stake them to earn interest.

  • Gifting crypto. Gifting crypto is usually tax-free, but this has a $15,000 limit. So, bigger gifts might attract taxes. Also, this limit does not apply to spouses. If you are not buying goods or services from someone and you send them crypto, that also counts as a gift.

  • Sending yourself crypto. Transferring digital assets between your crypto wallets is not a taxable event.

See countries with the least crypto tax.

How To Calculate Crypto Interest Tax

Calculating how much crypto tax you owe is not as easy as it may seem. This is because you might have transacted with various crypto exchanges in a tax year. Also, it might be challenging to separate taxable from non-taxable transactions.

The good news is that you don't have to do all these things yourself. You can use crypto tax software to track and calculate your crypto interest. They allow you to determine your taxable events and report them.

These tools do not all function in the same way, though. For instance, while Coinbase's software is efficient, it only covers Coinbase transactions. So, this software may not be for you if you use different platforms.

Koinly is another excellent tax software to use. This tool lets you import crypto transactions from different platforms. It then scans them and specifies which are taxable. The software also supports many crypto platforms. This makes it easier to calculate all your due taxes in one place.

Note that the report generated by crypto tax software is not an official tax document. So, ensure you countercheck the provided details for accuracy.

How Can I Report Cryptocurrency Earnings for Taxable Events?

Each country has its dedicated forms and documents for reporting taxes. In most cases, though, the documents are similar in purpose and structure. Let us now discuss how to report crypto taxes in the US. You might need to consult tax professionals in your country if you are not a US citizen.

We will divide the steps into four.

Step 1 - Track Your Crypto Transactions

This may not be easy if you are an active crypto user. You need to track your transactions across all the crypto exchanges you used in the tax year. You may even end up missing some due to fatigue or human error. And if you miss some, your tax report may be inaccurate. No one wants that.

So, to make things easier, you can use crypto tax software. It will help you track your transactions without much hassle. A good example is CoinLedger's software. It connects to your crypto exchanges and imports all your transactions automatically. It even generates tax forms and guides you as you fill them.

Step 2 - Fill out Tax Form 8949

This is the tax form that US citizens fill out to report capital gains and losses to the IRS. Below are some essential details you should include when filling out this form.

  • The name of the virtual currency

  • When you acquired and disposed of it

  • The FMV (Fair Market Value) on the purchase and sale date.

  • The net capital gain or loss.

  • Any other required information.

When filling out form 8949, you must specify whether your gain was short-term or long-term. This is because the tax rates differ depending on how long you hold the asset before selling. If you have had it for over a year, you qualify for long-term tax rates. You will pay short-term tax rates if you hold for less than a year.

Step 3 - On To Schedule D

Schedule D is the final document that records all capital gains and losses in a tax year. So when you're done filling out form 8949, transfer your calculations. Whatever gets here is final. So make sure you confirm the records before submitting them. That way, you'll avoid tax penalties.

Step 4 - Report Your Crypto Income

Form 8949 and Schedule D are for reporting your capital gains and losses. You also have to fill out your income tax reports. Here are some of the documents you must fill in various categories:

Schedule A

This form helps you report crypto income from crypto activities requiring little investments. These activities include airdrops, forks, crypto wages, etc.

Schedule B

This is for income gotten from passive crypto investments. Crypto lending and staking fall into this category.

Schedule C

This is for crypto miners or others who have crypto businesses. Based on the nature of their operations, they might also need to pay self-employment taxes (15.3%)

After completing these four steps, review the document and verify its accuracy. If you are sure that all is well and good, you can submit it. You will have paid your taxes fully for the tax year.

Conclusion

Crypto interest counts as income. We hope this article has explained why that is and how it works. Remember, though, that governments may have varying crypto tax rules. So, verify your location's specific tax rules to avoid legal issues. Also, reach out to tax professionals in your country for rounded tax advice.

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