Cryptocurrencies have been one of the most disruptive inventions in the financial world since the advent of the internet. Digital assets, which use blockchain technology for transparency, decentralization, and security, have attracted a growing number of investors, traders, and users globally. But the decentralized nature of cryptocurrencies and the lack of uniform tax regulations have led to confusion, complexity, and controversies, especially for governments and taxpayers.
In the United States, the tax treatment of cryptocurrencies varies from state to state, and Illinois is no exception. The Pasquesi Sheppard team in Lake Forest, Illinois, invites you to read below as we explore how Illinois taxes cryptocurrencies, including the legal framework, tax implications, and compliance requirements, among other aspects.
Before looking at the tax treatment of cryptocurrencies in Illinois, it’s essential to understand the legal framework that governs their use and regulation. The federal government doesn’t recognize cryptocurrencies as legal tender yet, meaning you can’t use them as a substitute for the U.S. dollar to pay for goods and services. But for tax purposes, they’re property subject to federal income tax, capital gains tax, and other regulations that apply to property transactions.
Like many states, Illinois still needs to develop clear guidelines on how to tax cryptocurrencies. The state has adopted the Uniform Money Services Act (UMSA) to regulate businesses that deal with digital currencies, especially those involved in money transmission, currency exchange, and other financial services. The UMSA requires such entities to register with the Illinois Department of Financial and Professional Regulation, obtain a license, and comply with various reporting and disclosure requirements.
Illinois has joined other states in supporting blockchain technology and cryptocurrency innovation. In 2017, the state passed the Blockchain Technology Act (BTA) to define and recognize the legal validity of smart contracts, electronic records, and digital signatures that use blockchain technology. The BTA also established a task force to study blockchain technology’s potential benefits and risks for the state’s economy, cybersecurity, and other areas.
When preparing your taxes, the implications of cryptocurrencies in Illinois cover two broad categories: income tax and sales tax.
Like all states in the U.S., Illinois follows federal tax rules for cryptocurrencies. For tax purposes, cryptocurrencies are property, which means they’re subject to capital gains tax, income tax, and other regulations that apply to property transactions.
If you’re an Illinois resident and bought or sold cryptocurrencies during the year, you must report your gains or losses on your state tax return. This includes all transaction types, such as buying and holding cryptocurrencies, trading them for other cryptocurrencies, and using them to pay for goods and services. You’ll calculate the gains or losses based on the difference between a cryptocurrency’s fair market value when you acquire and dispose of it.
For example, if you bought one bitcoin for $10,000 and sold it for $12,000, your capital gain would be $2,000. If you held the bitcoin for less than a year, it would be a short-term gain, and you would pay your ordinary income tax rate, which ranges from 4.95% to 7.99% in Illinois, depending on your income. If you held the bitcoin for more than a year, it would be a long-term gain, and you would pay a higher tax rate of 15% to 20%, depending on your income.
It’s essential to note that if you receive cryptocurrency as payment for your services, such as someone paying you in bitcoin for your freelance work, you must report the payment as income on your tax return. The cryptocurrency’s fair market value at the time of payment determines the revenue. It’s subject to income tax and self-employment tax, which is 15.3% for individuals who earn more than $400 in self-employment income.
Another aspect of cryptocurrency taxation in Illinois is sales tax, which applies to using cryptocurrencies to purchase goods and services. According to the Illinois Department of Revenue (IDOR), sales tax applies to purchasing tangible personal property, including digital products such as software, music, and movies that you download electronically. Unlike income tax based on the gains or losses from transactions, sales tax depends on the value of the transaction itself.
The IDOR still needs to issue clear guidelines on taxing cryptocurrencies, primarily when you use them to pay for goods and services. One of the challenges of taxing cryptocurrencies as sales tax is their volatility and complexity. Since cryptocurrencies are decentralized and no central authority issues them, their value can fluctuate wildly in hours or days. So it’s difficult for tax authorities to determine how much sales tax to collect, especially when the transaction involves multiple cryptocurrencies or conversions to fiat currency.
In 2014, the IRS stated that it considers cryptocurrencies property and subject to capital gains taxes. So if you sell or exchange cryptocurrency, you must report the transaction on your tax return and pay taxes on any gains realized. If you’re an Illinois resident who has bought, sold, or otherwise transacted with cryptocurrencies, you must maintain detailed records of your transactions.
At a minimum, these records should include each transaction’s date, the cryptocurrency’s value at that time, and the transaction’s purpose (e.g., investment or personal use). It’s also important to note that if you receive income in the form of cryptocurrency, you must report that income on your tax return, including income from mining, airdrops, and other forms of compensation paid in cryptocurrency.
If you’re an Illinois resident who uses or holds cryptocurrencies, you must follow the IRS’s taxation guidelines. These guidelines include reporting transactions on your tax return, maintaining detailed records, and paying taxes on any gains realized. It’s advisable to consult with a tax professional with experience in cryptocurrency taxation to ensure you’re complying with all applicable laws and regulations.
If you have additional questions regarding cryptocurrency, contact the experts at Pasquesi Sheppard in Lake Forest, Illinois. We’d be happy to talk to you about your tax situation, whether it includes cryptocurrency or not. Call us at 847-234-5000 or complete our secure online form to get started today.