Get a passport, pay crypto, live tax-free?

Most transfers of cryptocurrency are taxable, unless the transfer is qualified as a gift or a charitable contribution.

Way back in 2014, the United States Internal Revenue Service (IRS) ruled that cryptocurrency is property in Notice 2014-21. That classification as property has some big tax consequences accentuated by wild price swings. Buying and selling crypto can trigger gain or loss and be taxable. Yes, buying something using crypto — a house, a car, a new suit — can trigger taxes. Even paying taxes in crypto can trigger taxes.

If you owe $5,000 in taxes, you could pay the $5,000 in dollars. However, if you pay with $5,000 worth of Bitcoin (BTC), as long as the crypto is worth $5,000 when you pay, you’re home free, right? Not really. You need to consider the sale you just made. The transfer of the crypto to the tax man is a sale, and that could mean more taxes for the year of the payment. If you bought the crypto for $5,000 the day you pay your taxes, there’s no gain.

Crypto as a gift

Paying employees or independent contractors in crypto results in taxes to them when they receive it. And when you pay them, you too can have a tax hit since, on your side of the equation, you just sold your crypto. If you are paying with crypto, remember that most transfers of crypto are taxable, unless the transfer qualifies as a gift or a charitable contribution. You can give crypto as a gift, and it doesn’t trigger income taxes. That’s right, no income tax to you as the donor, and no income tax to the recipient.

Of course, when the recipient transfers or sells it, there would be income taxes then. And at that point, the donee would need to calculate gain or loss. What is his or her tax basis, since it was a gift? The tax basis is the same as it was in your hands when you made the gift. However, keep in mind that to avoid income taxes, a gift has to actually be a gift. The tax law is littered with cases of people who claimed something was a gift, but who got stuck with income taxes.

With gifts not being subject to income taxes, it can seem tempting to try to characterize money or property you receive as gifts. But be careful: The IRS hears this “it was a gift” excuse a lot. And the IRS is unlikely to be persuaded unless you can document it. Plus, the IRS usually expects a gift to occur in a normal gift-giving setting. For example, if an employer or former employer gives a loyal employee $10,000, is that a gift? No, it is a bonus, treated as wages. Even trying to document it as a gift may not change that result.

True gifts may not trigger any income taxes, but there could be gift taxes involved. If you give crypto to a friend or family member — to anyone really — ask how much it is worth. If the gift is worth more than $15,000, it requires you to file a gift tax return. For 2021, $15,000 is the amount of the “annual exclusion.” You can give gifts up to this amount each year to any number of people with no reporting required. Any gifts over that $15,000 amount require a gift tax return, even though you may not have to pay any gift tax. Rather than paying gift tax, you normally would use up a small portion of your lifetime exclusion from gift and estate tax.

What if your gift isn’t to a person, but to charity? If you give to charity, that can be very tax-smart from an income tax viewpoint. If you give crypto to a qualified charity, you should normally get an income tax deduction for the full fair market value of the crypto. If you bought it for $500, and donate to a 501(c)(3) charity when it is worth $15,000, you should get a $15,000 charitable contribution deduction.

What’s more, you won’t have to pay the capital gain or income tax on the $14,500 spread. That’s a good deal. It’s…