Your Kid Is A Crypto Whiz? You May Soon Face A Hefty Tax Bill

A growing number of teens are dabbling in cryptocurrency. That adds a wrinkle to already murky rules surrounding crypto taxes on digital assets for children and guardians alike.

If your child is one of the 9% of American teens who have traded digital currencies, according to a Piper Sandler survey, their gains could saddle you with a hefty tax bill. The Internal Revenue Service considers cryptocurrency intangible property, which can trigger unearned income when dependents are trading digital currencies or buying and selling goods with it.

That's where the so-called Kiddie Tax law comes in. It applies to unearned income from stock and other investments of children under 18 and full-time students between 19 and 24. But it does not apply to salary or wages.

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No Escaping Crypto Taxes

The Kiddie Tax works like this for the 2021 tax year for returns filed in 2022: Unearned income under $1,100 qualifies for the standard deduction. The next $1,100 is taxed at the child's tax rate, which is very low and sometimes 0%. Then the marginal tax rate, which can be as high as 37%, kicks in for anything over $2,200.

So what should you know, generally, about crypto taxes? Los Angeles-based CPA Jordan Bass says the key is to be aware that reporting crypto activity to the IRS is a must for everyone, adults and minors alike.

"This isn't a magic space where you gain wealth and you don't have to report it," Bass said.

Furthermore, even if you don't make a profit, it's key to report your transactions. Report your gains and losses as accurately as you can, Bass says. The IRS has not been aggressive in the crypto space yet, but if you don't report crypto activity at all, it could eventually raise a red flag.

For example, tax Form 1040 now asks if you've received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency. Be honest. Claiming ignorance is no longer an option. You want to avoid penalties, fees and, in extreme cases, tax evasion charges.

Here's when to report:

If you trade one digital currency for another.

When you sell cryptocurrency for U.S. dollars or another government-issued currency.

If you use crypto to buy good and services.

Tax prep steps:

Collect data. Bass says it's your responsibility to get all the data from every digital wallet you've ever used. Crypto exchanges won't be required until 2023 to send you tax summaries in the form of 1099-B forms. Consider using software that helps you keep track of all your transactions. Popular crypto software includes: Cointracker, ZenLedger and Koinly.

Hire a tax professional. Find someone who is well-versed in cryptocurrencies. They will be crucial in properly calculating gains and losses for crypto taxes. 

Set aside money in case you need to pay a hefty tax bill.

Help Your Teen Navigate Crypto Taxes

Understand that the buck stops with parents and guardians when it comes to teens' crypto taxes and activity. 

"What I would do if it were me and it were my child, I'd want to know what they're doing because you don't want them to get involved in some sort of transaction where they've generated some money and then all of a sudden someone takes advantage of them and their funds get lost," Bass said. "That becomes an issue because those theft losses cannot be deducted."

There are a lot of options out there for teens to test their chops in cryptocurrency, some more reputable than others.

Abigail Li, a 16-year-old junior at Hunter College High School in New York City, started the website to help teens sort the chaff from the wheat.

Li says she spent a lot of time over quarantine reading about crypto on social media sites like TikTok and Meta Platforms' (FB) Instagram.

"A lot of the sources I found weren't exactly reputable," said Li, who says she interned at Apifiny, a New York-based digital asset trading network. "I had a solid background and understanding through my previous exposure, so I could see how biased the sources were online. There were a lot of pump-and-dump schemes. There were a lot of fraudulent people out there putting out information."

Li's website addresses that misinformation and also promotes overall financial literacy among teens.

How To Avoid Tax Pain From Your Teen's Crypto Gains

If your child is generating tens of thousands of dollars of crypto gains, that could mean thousands of dollars in taxes owed.

"You want to make sure they are aware that this is not just money that's coming to them without anything they have to pay because of their age," Bass said. "That's not how it works. And it's on parents to be aware of what their children are doing."

Bass adds that it might not be tax advantageous for high-income parents to tack on their child's crypto earnings to their tax returns. Instead, it could be wiser for teens to file their own return, even if parents lose the dependent-child tax credit. Why? Because the extra crypto gain could be large enough to push parents into a higher tax bracket, Bass says.

Parents might also want to consider how long their teen has been holding the crypto assets. Gains are taxed at either short- or long-term rates. Assets held for less than a year are taxed as ordinary income, which can go up to 37%. Assets held for longer than a year are taxed up to 20%, depending on your filing status and taxable income

Finally, be on the lookout for more crypto regulations in the near future. President Joe Biden on March 9 signed an executive order calling on the federal government to examine the risks and benefits of cryptocurrencies.

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