How to Do Crypto Trading Accounting for Taxes?
This is the third and final part of our in-depth guide to crypto accounting for businesses. Previously, we introduced the topic and discussed how to manage crypto accounting. Now, we’ll explain how readers can handle related taxes, crypto mining accounting, as well as take a look at common issues associated with this kind of accounting.
There is no universal explanation on how to do accounting for taxes when it comes to crypto payments. This is because the way taxes are managed largely depends on national legislation and how a particular legal system defines crypto. Therefore, your treasury will have to customize the accounting according to your local legislation.
For example, the current legality status of bitcoin in the EU and UK is that it is a digital, intangible asset that is risky, but not illegal to own, trade, or mine. However, the way each of the European countries treats Bitcoin is different. While Germany sees bitcoin as a personal asset, in the UK it is a capital asset, while Slovenia defines cryptocurrencies as neither assets nor currencies.
The fact that crypto is recognized as an intangible asset, means that using it as a means of exchange might call for warrant adjustments. Also, additional disclosures to Cash Flow and Profit and Loss statements might be necessary as well.
At the moment, most governments accept tax payments only in fiat currencies and official legal tenders.
Do My Financial Statements and Tax Reports Have to Align?
No, the rules for your financial statements and your tax reports won’t be the same every time.
Let’s say you have unrealized losses in crypto trading. In that case, and especially when there’s an impairment event, you will have to make entries in the account books according to the IFRS and GAAP rules. These don’t necessarily imply a tax deduction for unrealized losses.
You can easily determine the cryptocurrency tax by separating all of your transactions into three main groups:
- Those that generate income taxes
- Those that generate capital gains taxes
- Non-taxable activities
Actually, determining the tax basis is much less of a problem for most companies processing crypto than GAAP reporting.
GAAP and IFRS Perspective: Taxable Transactions
Here is a list of activities that are usually considered taxable:
- Any income generated through mining
- Earnings generated through interest
- Hard forks.
If your company earned any value from these activities, then these gains should be mentioned in your yearly gross revenue. As such, they are treated as usual business income.
Naturally, if these activities imply any costs and expenses, these get to be deducted.
On the other hand, any activity other than selling, exchanging, or paying a vendor generates capital gains tax
According to a general definition, any activity that doesn’t fall under income tax or capital tax, is non-taxable. Although local regulation might vary, in general, these activities are usually non-taxable:
- Buying crypto with fiat
- Donating crypto or giving it as a gift
- Transferring crypto between exchange platforms
The Crypto Price Volatility and Value Determination
When calculating your taxes, trading in virtual currency is seen as a nonmonetary exchange or barter transaction. Therefore, the value is calculated at the time of receipt and must be documented as such.
Additionally, payments in cryptocurrencies call for gain or loss recognition. Therefore, keeping a record of the cryptocurrency transaction details is of vital importance for calculating the tax base. Having documents that prove how cryptocurrency value is calculated is a must.
Using Crypto For an Expenditure
When a company uses crypto for purposes of expenditure, this will trigger the following:
- The gain or loss on the crypto
- The expense or payment itself.
Again, it is extremely important to have documents and proof that support the estimated crypto value.
If you want to pay vendors using crypto, this transaction needs to be recorded the same way as if the crypto was being sold: it will count as disposal. In turn, the difference between the expense and the calculated value of the crypto asset represents the capital gain.
Example 1. Let’s say you hold 200 BTC in your wallet. When you bought these coins, their price was $350,000. In the meantime, the value went up to $450,00. At the same time, your company needs to pay a third part company for performing an audit. They require $450,000, and you wish to pay them in crypto.
How will your ledger see this situation?
Firstly, you will put a $450,000 debit to your expense account, as a cost of professional services. Then, you will credit your Bitcoin asset account for $350,000. Finally, the remaining $100,000 will be credited to the capital gain account.
Example 2. Again, you hold 200 BTC in your wallet and their original price is the same ($350,000). However, what if, this time, their price went down to $250,000 and then came back up to $450,000? In that case, you would record the impairment once the drop in value happened, so you wouldn’t be able to account this as a capital loss. On the contrary, you would record a capital gain of $200,000, as a difference between the original book value and its current fair value.
Crypto and Payroll
If your company wishes to pay salaries in crypto, you need to keep in mind that most legal authorities don’t accept crypto. That means that you will have to pay withholding taxes in fiat currency, which might imply additional transactions and fees.
Furthermore, crypto doesn’t come with usual bank statements, so you will have to make additional effort to capture and disclose all relevant documentation. In other words, you will need to take responsibility for supplying the required information to the authorities.
How to Do Accounting for Cryptocurrency Mining?
Without mining, there is no blockchain and no circulation of crypto assets. If you’re running a company that is partially or fully engaged in mining activities, you’re probably wondering how to set up accounting books for cryptocurrency mining.
For sure, any mining activities need to be recorded in your ledger. You will record them as income-generating activities, by crediting your mining income account while debiting the account with the generated crypto assets at a properly estimated market value.
Although that problem might be solved in near future, the fact that mining consumes a lot of energy is bad news for the environment. However, it is good news for your taxes. Since mining implies significant costs, so you will be able to deduct those from your income and in turn, get a lower tax base.
And since you will probably use fiat currencies to pay for the mining (i.e. electricity), make sure to credit the cash account. Then, you will either debit an asset account or treat the cost as an expense.
Common Crypto Accounting Issues
If you decide to start using crypto in your cash flow, prepare for questions without certain answers and legal dilemmas from time to time. Here is a list of issues companies usually have when trying to operate and account crypto.
From the perspective of accountancy, crypto doesn’t have much to do with money. Rather, it is an intangible asset. And, to complicate things even more, intangible assets with frequent and, oftentimes, unpredictable shifts in value. This is the main obstacle to treating crypto assets as cash equivalents in your ledger.
The companies usually use an alternative approach and treat them as aforementioned intangible assets, inventory or financial instruments. Understandably, none of these categories fully match the true nature of crypto assets, and it is where the problems occur.
The most common approach, that of intangible asset, is problematic mostly because it treats crypto assets as indefinite-lived, while the value often dips below the cost basis.
- Unrealized losses are recorded, but gains aren’t
In the U.S., unrealized losses get recorded but not gains. The current regulation doesn’t leave any space for changes that would record the subsequent impairment losses. And this can be tricky if the asset later grows back and surpasses the initial values.
This is what it looks like in real life. Your company purchases $600,000 worth of Bitcoin, whose value then drops to $500,000. The ledger will require you to account for a $100,000 loss, and reduce your Bitcoin holdings. In the meantime, the value of Bitcoin goes up to $700,000. However, the law doesn’t allow you to change the balance sheet and change the loss amount and has to stay at $500,000.
Then, a representative of a tax authority checks your financial statements and notices the incongruencies. It can easily lead to a misunderstanding and a wrong conclusion that you might be hiding something.
To Wrap Up: It’s Complex, But Doable
A decision to welcome crypto in your company’s financial system is a big one. There are a lot of considerations to take, many changes to make, and a lot of uncertainties to face.
Still, there are many companies that manage this, and their success is the best proof that it is possible. From international giants like Microsoft and Tesla, to Subway and Pizzaforcoins, these businesses are showing us that obstacles aren’t insurmountable. Although implementation of crypto transactions will require some time, effort, and investment, billions of dollars of these companies’ revenue show that crypto is the future of finance.
And with this, we conclude our guide. Hopefully, things are clearer now and you’ll soon be on your way towards introducing crypto to your business and handling its accounting demands with no issues. Here, you can find Part 1 and Part 2 of the guide.
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