Digital currencies can have many aliases. First, they are called cryptocurrencies, virtual currencies, and other names. Beyond their synonyms, we assume you have heard of several popular types of digital currencies such as Bitcoin, Litecoin and Ethereum.
Cryptocurrencies are increasingly popular alternatives for online payments. We are here to put things in order and help you gain knowledge and know all the relevant information for you regarding the taxation of digital currencies, the risks of not reporting about it and how to deal with the authorities.
A bit about the world of cryptocurrencies
A digital currency is a virtual currency that is an alternative payment method created using cryptographic encryption algorithms (cryptography is actually the field of encryption). The use of encryption technologies actually creates a situation where the digital currencies function both as currency and as a virtual accounting system.
It should be noted that in order to use digital currencies, one must first purchase a virtual wallet. These wallets can come as software that is a cloud-based service or it can be stored on your computer or mobile device. The wallets are the tool, through which one stores their own encryption keys, which confirm one’s identity and are linked to the digital currencies one holds.
The taxation of digital currencies
When there is a new product of economic value on the market, the tax authorities wish to understand how it makes money and what the most correct way to classify it is. If they do not do so, this will cause an irrational traffic and transition from a certain type of investment to another, only because of taxation. Since this does not lead to real economic value, then there is no will to incentivize it.
This can be compared to the capital market. In the past, there was no taxation on private gains in the capital market. This created an incentive to invest specifically there and not in other investment channels. As a result, in 2003 it was realized that there was a systemic failure and the taxation rate rose to 50%.
Since the taxation was too high, after several years and until today, the capital gains of private individuals are taxed at 25%. Given that the Bitcoin currency will not be taxed and seen only as cash, this may create an incentive to exit the capital market and go invest in Bitcoin only, something that does not serve the aggregate well-being and therefore requires the deepening of taxation.
Issues in classifying digital currencies
The main significant legal issue depends on the definition of cryptocurrencies. Since these currencies fundamentally undermine the notion that an economy should be under the responsibility of the government and centralized financial entities, it is not clear that they can be defined as currency.
That is, in practice, some hold the opinion that it is indeed a currency, but in a digital configuration, while there are others that hold the opinion that it is a real intangible asset. Accordingly, some will say that this is a type of security and more. Each of the classifications described above has a large-scale taxation implication, so it is necessary to be prepared for it and conduct things accordingly.
The legal framework of digital currency taxation in Israel
Many questions were asked on the subject in Israel. Thus, meetings were held and wide-ranging reports were issued on behalf of the Ministry of Finance, the Bank of Israel, the Securities Authority, and more. Even the courts discussed these issues. However, so far, there is no clear legislative regulation of the subject in the Israeli legal system.
However, the Tax Authority, which has seen the importance of Bitcoin since its early days, published a circular in 2018. In this circular, the authority clarified its position regarding the aspects of income tax, V.A.T and even international taxation in the context of virtual currencies.
Thus, in Israel, similar to the USA, the tax authorities ask in the annual tax reports a question regarding holding of and activity in virtual currencies. The reason for introducing the above-mentioned question stems from the Tax Authority’s desire to be ‘on guard’ and to know how to deal with people who did not immediately declare about trading in these currencies.
In recent years, the tax authorities have been able to establish contact with a number of currency exchanges and thereby obtain information on actions taken by potential taxpayers. With this information, the IRS is able to track down people who have not paid, collect payments from them and sometimes fine them for not paying.
The taxation system in Israel in relation to digital currencies
In fact, when talking about taxation, the most central issue is whether digital currencies should be taxed in the form of a “currency” similar to the familiar fiat currencies such as the shekel, dollar and euro or, alternatively, whether it should be classified as an asset.
In Israel, the digital currency is seen as an asset and not as an actual currency. That is, it can be compared more to trading in art, bonds or stocks and the form of taxation will be according to uniform tax rates.
That is, capital gains tax rates. This is in contrast to a progressive tax rate (according to business and occupation) or a reduced tax (for example, a 10% tax on apartment rentals by private individuals).
If you know the rules of the stock market – it is actually the same thing. If you sold your currency, for example Bitcoin, at a profit – then you will have to pay a 25% tax on the profit. Some of you will fall into the category of an additional 3%.
However, even here it should be remembered that if your occupation as employees or self-employed is trading in digital currencies, you will be exposed to a progressive tax rate, depending on the level of your salary.
The USA taxation system in relation to digital currencies
Another matter that concerns the taxation of digital currencies and you will probably want to know about it, and that is the situation in the United States. So generally, similar to Israel, the classification of digital currencies is as an asset and not as a currency.
There, the tax rates are divided into two types: if one holds a currency for more than a year – the capital gains tax rates will be lower and will range from 0% to 20% plus an additional tax of 3.8%, if necessary.
On the other hand, if one holds a currency for less than a year, the tax rates will be the regular rates, according to the personal tax rates of each taxpayer, that is, progressive tax rates. In most cases, the tax rate will vary between 10% and 37% plus an additional tax of 3.8% (also if necessary).
Tax report even at a loss
It should be noted that it is important to report to the tax authority even at a loss, because in some cases losses can be offset against future profits. Note that this rule only applies in this direction. Therefore, if there are future profits (after more than a whole year), and then you have realized the digital currencies at a loss, then the taxation of the digital currencies will not be offset.
Summary
We hope we answered everything you wanted to know about digital currency taxation. This field is important and it must be remembered that if a report is not done properly – you may be charged with legal liability that may cost you a lot of money and even jail time, since tax evasion is a criminal offense.
Therefore, with any question and assistance – we recommend contacting the crypto lawyer Daniel Yanovsky who will help you conduct yourself in the most correct and smart way and avoid costly and unnecessary mistakes.
