Your attempt to get clarity around crypto tax brainteasers can result in some surprising and unexpected tax liabilities at this time of year.
As we’ve seen through the CoinDesk crypto tax series, there’s a whole new realm of tax considerations that didn’t exist four years ago. Maybe you’re caught in a crypto squeeze play, wondering how to pay tax liabilities by liquidating the crypto you don’t want to liquidate.
Perhaps you’re finding out that some crypto you received at its highest historical price is taxed as ordinary income and now it’s worth 30 percent of its former self.
For example, you got paid in Xcoin on the date of its $32 historical high, then the floor dropped out of the market, the price slid to $9 and you continued to HODL. Then you sell all your Xcoin at $9 to cover the tax and end up back at zero.
These situations are not for the faint of heart.
Extensions and payments
If you need more time to gather information for your crypto tax calculations, you can always file an individual extension on April 17 for tax year 2017.
Importantly, extensions only extend the time to file, not to pay taxes. Filing tax returns and making the related tax payments are independent of, and parallel to, one another.
Payments have to be timely to avoid penalties and interest, regardless of whether you file on time or extend your return.
Penalties as friends
Generally speaking, if you made estimated tax payments for 2017 equal to or greater than your 2016 tax, then you’re in the safe harbor for that big tax payment on your once-in-a-lifetime gains until the April deadline.
For example, if your 2016 tax was $30,000 and you estimate 2017 taxes at $150,000, you should have paid 2017 estimated taxes of at least $30,000, which leaves you needing to pay $120,000 on the April due date.
But what if you can’t pay or don’t want to pay the tax at the moment penalties and interest start accruing?
This could be a strange-but-true tax strategy where you end up with more resources rather than less. Penalties and interest are seen as a taboo paradigm, but sometimes they can be your friend.
Individuals can generally get an installment agreement for a tax liability of $50,000 or less, including penalties and interest, for up to 72 months, no questions asked.
Businesses can get a similar arrangement for $25,000 or less. Anything over those amounts requires you to go under the IRS microscope by filing additional paperwork.
For example, you’re an individual with a $150,000 tax liability, so you painfully pay $100,000 and then finance the remaining $50,000 by using and managing future cash flows and crypto appreciation.
You make several monthly payments of $800 each until the crypto market explodes later in 2018, allowing you to sell for big gains while paying your tax in full with a smile.
In this scenario, you’ll have paid $3,500 in penalties and interest, but you benefited from $65,000 of appreciation by leveraging the IRS gift of installment payments.
In addition, liquidating any position in a hurry, crypto or otherwise, is not a good investment strategy, and an installment agreement buys you time to systematically liquidate – like dollar-cost averaging in reverse.
You will also likely end up with more resources using this method rather than an all-at-once liquidation near the tax deadline.
There’s still risk
All else equal, you should always pay your taxes in full and on time. However, if you’re willing to take the risk, now you know how to do it and take advantage of tax financing.
Keep in mind that instead of a sustained crypto market rebound, the opposite could happen and your portfolio could tank further, putting you in a worse position.
It’s a game of hedging and managing resources. Die-hard crypto enthusiasts already know this well.
Photo via Shutterstock.