A step-by-step manual to help NFT artists understand taxes and discover strategies to lower their tax liability
Many independent artists may have released their initial non-fungible token (NFT) this year, imitating the major brands of today. Because cryptocurrency earnings differ from typical corporate cash flow, the tax filing procedure will be unique for artists who are domiciled in the United States.
“Creators must be thinking about taxes,” said Justin Macari, a CPA with a New York City base and a well-known Zen Ledger tax expert.
But given the explosive growth of NFTs since late 2021, it’s possible that artists who recently switched to selling digital goods did so without fully contemplating the consequences of taxes.
not claiming NFT income. This year, a lot of artists experimented with NFTs, and anyone who made money from NFT sales could claim that income on their taxes. However, amateurs are taxed differently by the Internal Revenue Service than individuals who make a career from their art.
Step 1: Decide whether you are a professional or a hobbyist creator
Work with your accountant to finish the “material participation” test checklist. This list of requirements aids company owners in determining which of their income-producing activities will be subject to self-employment taxation at the maximum rate and which areas of their operation will be eligible for any applicable deductions or credits.
500 hours are what the IRS defines as “material engagement,” according to Macari. Start preparing to claim your NFT sales earnings as self-employment income if, by the end of 2022, you will have spent 500 hours or more creating NFT artwork—roughly nine to ten hours per week.
Because company owners must additionally pay the Medicare and Social Security tax payments that employers often deduct from their employees’ paychecks, self-employment tax rates are frequently higher than conventional income tax rates. On their NFT sales, hobbyists often simply have to pay their standard income tax rate, which is computed as a proportion of their aggregate total adjusted taxable income and earnings (W-2 income, side hustle revenue, 1099 gigs, etc.).
“A creative who has a full-time job already qualifies as a hobbyist.” Their primary source of revenue is not from NFTs, according to Shehan Chandrasekera, head of tax at cryptocurrency tax software provider CoinTracker.
According to Chandrasekera, the disadvantage of hobbyist creators not being able to deduct business expenses outweighs the fact that they frequently pay fewer taxes than full-time, self-employed creators. On the other hand, those who record NFT income as company revenue can write off expenses for things like devices, software subscriptions, and even a percentage of their power bill.
Step 2: Be prepared
A series of taxable events may occur as a result of purchasing or minting an NFT, so it’s important to keep track of them all. Although blockchains have previously been used to record the majority of NFT activity, crypto tax software can assist with reporting in ways that blockchain isn’t intended to. Joining a portfolio tracker that can send an activity report to your accountant or a tax software program like TurboTax is worthwhile.
Precise revenue counting
It’s a “big fallacy,” according to Macari, that authors are exempt from reporting cryptocurrency earnings that are still in their digital wallets. Let’s clarify that: business owners must report all of their income, regardless of whether it was received in fiat money or cryptocurrency or whether it was transferred to the bank or not. Claim the cryptocurrency’s value at the moment of receipt, not at the time of transfer.
Quinn, for instance, exchanged 0.2 ether for an NFT (ETH). 0.2 ETH was approximately $400 at the time. Quinn waits two months before exchanging the ETH for USDC and then selling the USDC for cash. After fees and market swings, Quinn tends to end up with $340 in her savings account from the sale of her USDC, which is worth $360 by the time she converts it for cash. However, Quinn must include $400 in her tax return as income, starting from the moment she sold it.
Figuring out the cost basis
Most cryptocurrencies and NFTs are classified by the IRS as digital assets, with very fluctuating valuations, at least for the time being. When purchasing and selling ETH, the most widely used cryptocurrency for NFTs, or any other type of cryptocurrency, it’s important to record any capital gains and losses.
On the Ethereum blockchain, “gas fees,” or transaction costs, must be paid to mint an NFT. Some platforms enable artists to pass on transportation expenses to the buyer, so they are not necessarily required to cover them before selling their work. The cost basis of the NFT, and consequently the value of capital profits or losses the inventor must pay, are nonetheless impacted by paying gas costs. For hobbyists who are unable to deduct gasoline costs as a business expense, the cost basis is a crucial factor.
A good sales history will also help you account for the taxes you’ll have to pay on each sale of an NFT, whether you sell it for a profit or a loss.
Maximizing tax deductions for company
For full-time creators, gasoline costs can also be written off as a legitimate company expense. The minting costs (also known as “gas fees”) that artists who coined the NFTs on the blockchain before selling them paid should likewise be documented.
Step 3: Think about credit for research and development
Macari urges producers of boundary-pushing NFT initiatives to apply for a tax credit for development and research under Section 174 of the tax law because of the experimental aspect of blockchain.
According to Macari, this credit is superior to typical business deductions since qualifying firms can use it to deduct a percentage of their unpaid taxes.
According to him, a tax credit has always been preferable to a deduction since it lowers your taxes on a dollar-for-dollar basis, whereas a deduction just lowers your taxable income.
Costs associated with employing developers or making an investment in specialized technology are examples of qualifying research expenses.
“If you’re constructing something where it’s not clear exactly how this will turn into anything practical, so it’s a high-risk investment, but you’re going to build something creative, new, and innovative — something that’s a subjective issue in nature,” says Macari.
Step 4: Find a CPA with experience in the crypto industry
Working with a tax expert who is familiar with the peculiarities of the industry is essential if you’ve done a significant amount of your business in the cryptocurrency space since 2022. Use the remaining months of 2022 to begin looking for and speaking with accountants, or inquire about the capabilities of your present accountant in the constantly shifting world of cryptocurrency.
In cases where you are unsure, check the websites of cryptocurrency portfolio tracking businesses to see whether they offer a list of affiliated tax experts or if you can increase your membership to include one-on-one help.
