Let’s have a look at how you might build up your assets in a different method that will save you money. This strategy works especially effectively if you’ve purchased something that has skyrocketed in value. If you sell or diversify out of that product, you’ll be hit with a hefty tax payment.
Over the past decade, cryptocurrencies have proven to make excellent investments for traders that get the timing right. If you manage to buy the dip, it’s possible to see massive returns on the next bullish run.
In fact, “Thomas Fitzpatrick, CEO of Citibank, predicts Bitcoin will reach $318,000 by 2022.” If that comes to be and if you invest in crypto correctly, you could have a big profit on your hands. But how do you go about withdrawing it without paying exorbitant taxes?
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Capital Gain Taxes and Crypto
Let’s imagine you put $5,000 into Bitcoin a few years ago, and it’s now worth $25,000, a 500% increase. However, you’ll have to pay taxes if you wish to sell or diversify. The good news is that you’ve held the position for more than a year, which means no short-term capital gains, but the bad news is that you still have long-term capital gains taxes, which may build up quickly.
If you sold that $25,000 in Bitcoin, you’d have to pay a 20% long-term federal capital gains tax. States must get a share of the activity, ranging from 0% to 13.33%, depending on the state. States have an average capital gains tax of 5%. For this example, we’ll use a total capital gains tax rate of 25%. Your $20,000 profit would be taxed at a rate of 25%, resulting in a tax bill of $5,000. You can, however, do something about it.
It’s critical to remember that you only have alternatives before selling. Your choices are essentially gone if you’ve already sold your assets. You’re going to save $5,000 by using a charitable remainder trust, which is a legal method to save a ton of money while also doing good for society and leaving money for your kids.
According to Investopedia, the charitable remainder trust distributes revenue to trust beneficiaries for a certain period of time before donating the remainder to the charity. You may believe that giving to charity is a wonderful idea, but you want to put your investment money to good use. But don’t get your hopes up. If you sell, you’ll have a tax bill of $5,000.
Avoiding Capital Gains Taxes
To begin, contact a lawyer and ask them to construct a CRT. Then you should pick a charity to which you will contribute your funds. That charity must be a recognised 501(c)(3) organisation. Then, you name yourself a beneficiary of the charitable remainder trust for the rest of your life.
You’ll give your $25,000 in crypto, equities, or other assets to your CRT now that it’s up and running. Your CRT will have its own crypto wallet to which you will send the cryptocurrency. It’s a wholly distinct entity from you.
It’s worth noting that your CRT is a nonprofit organisation in and of itself. As a result, by moving the assets, you may immediately claim a tax deduction for placing them into a company and contributing money to your own charitable trust. As a result, you obtain a tax deduction right away. However, you won’t get a full tax credit on your donation because you aren’t technically donating to a 501(c)(3) until you die.
There is a thing called a present value calculation on your money. It exists because money will be worth less in 40 years than it is today, so instead of deducting 100%, you may be able to deduct roughly 30% to 40% of your taxes. Of course, this would differ slightly if you were to contribute to a private institution such as a college or your own charity. Using those alternatives, the tax would be a little less than 30% or 40%.
Assume, however, that you’re contributing to a public qualifying institution and that you’re going to estimate on the low end with a 30% tax deduction. This implies you just earned a $6,000 tax break on our $20,000 investment.
However, you do not receive all of this in the first year. The way it works is that you get to deduct 60% of the sum from your income every year for the next five years. So you might deduct $3,600 in the first year, and gradually lower sums over the next four years which will amount to $6,000 in total.
This lovely little tax break is yours for the next five years, but it doesn’t end there. You’ve only transferred your Bitcoin to the charitable remainder trust thus far. There’s a lot more fantastic stuff on the way. After all, you haven’t sold your asset yet.
The next stage is to put it on the market. Because it’s not truly you who’s selling it, you’re selling it capital gains tax-free. It’s being sold by a charity, and those don’t have to pay taxes.
Here’s how you get the most out of the situation. You have alternatives now that you’ve sold your investment. Other assets inside the trust might be purchased. You may buy land, a company, and even more cryptocurrency. You may purchase almost any asset.
After that, you create an annuity. This might be based on a percentage or a fixed sum each year. Until you die, this will be paid to you from the charitable trust. If you’re going to use percentages, you’ll need at least 5%. For the sake of this example, we’ll choose a 7% yearly payment. So, you get paid 7% of your $20,000 salary every year. This works up to $1,400 every year till you die.
Mind you; we are dealing with a very small example of $20,000 worth of profit here. If you make more and set up your charity fund with more wealth, you’ll get much higher returns.
What’s more, depending on the success of the portfolio, give or take a small amount, a charity will also benefit in the end. Some of your funds will go towards your chosen cause.
It’s crucial to note that the annuity payments are taxed at your usual income tax rate each year. But remember, owing to your first $20k donation, you get a lovely little tax break for the first five years. The money in this trust is completely secured from personal liability, which is a nice bonus. You cannot use your charity trust to pay it off if you have a personal responsibility. When you die, you can leave some of your money to your children rather than giving it all to charity.
Irrevocable Life Insurance Trusts
You contact your lawyer and ask them to set up an irrevocable life insurance trust (ILIT) for you. According to Northwestern Mutual, an ILIT is a form of trust that’s funded with one or more life insurance policies during your lifetime.
This is a $20k life insurance policy that you’ll buy for yourself. You’ll have to pay for it out of your annuity instalments. You may pay this insurance over the course of 20 years if you like, or you can just overpay it for the first five years while taking advantage of those wonderful tax deductions and then never pay it again, leaving the same $20,000 to your loved ones when you die. This is when money becomes enjoyable.
There are a few drawbacks to this that you should think about. For starters, this usually needs a large number of assets. It appears that you’ll need at least $100,000 in profits for this plan to start making sense.
Secondly, charity trusts are designed to be unchangeable for tax reasons, so you won’t be able to quickly withdraw assets or alter the beneficiary later. After you sign the paperwork, a lot of it is set in stone. Third, even while you continue to profit from the trust, you lose legal control of the assets within it.
Use Tax-Free Thresholds to Your Advantage
In most countries around the world, citizens are granted a certain threshold under which they don’t have to pay taxes, provided that it’s under a certain amount. This is one of the best ways crypto traders can avoid paying taxes on their digital assets.
Tax-free thresholds vary wildly around the world. If you’re in the UK, you’re one of the fortunate ones! Brits are granted an annual tax-free allowance of around £12,300. Anything under that is free of tax! On the other hand, things are a little tighter if you’re in Germany. Your annual tax-free allowance is only for profits of €600 and under.
In the U.S., things are even more generous than in the UK! According to the Internal Revenue Service (IRS), if you make less than $41,676 a year, you’ll be given the privilege of paying no Capital Gains Tax.
If you’re legally married, there is another loophole for you to avoid paying tax on your crypto. Married couples who file their annual accounts together are granted a tax-free allowance of just over $83,000 a year.
And speaking of spouses! There’s also another excellent way to avoid tax on crypto if you’re married.
Move Digital Assets to Your Spouse
In various countries worldwide, authorities give tax-free privileges to married couples or those in a civil partnership that can be taken full advantage of by crypto traders. To draw on the UK again, for example, crypto transfers between spouses are currently a convenient tax-free loophole as it’s classed as a gift.
And again, married couples can combine their annual allowance to double the already generous tax-free allowance. However, the clause is that you need to be currently living together and not be separated for this to apply to you.
Use a Crypto Tax Calculator to Single Out Losses You May Have Missed
Unless you keep a keen eye on your crypto portfolio, it can be difficult to spot chances and opportunities to shrink your annual tax payments. Many crypto experts worldwide recommend that traders utilise a tried and tested crypto tax software, tax calculator, or similar tool.
For example, if the financial year is drawing to a close, you’ve made some great profits on the crypto market through promising price predictions on the likes of Ethereum, and you now have a large tax bill looming, you can use a crypto tax software to figure out losses you may have forgotten about in the thrill of the profits.
In contrast to your high-performing assets that have netted you a profit, you may find you have some obscure altcoins that are currently underperforming and have, on paper, lost you money. You can then sell these dead-weight digital coins at a loss, which can be offset against your overall tax bill.
This is also often referred to as tax loss harvesting.
And so, to sum up, this guide on avoiding tax payments on crypto in a variety of legal ways, we’ve left no stone unturned in our quest to reveal some of the most tried-and-tested ways to maximise your crypto profits as much as possible and skip the annoyance of paying tax.
Curious about other aspects of savvy investing in the world of crypto? Check out these other unmissable articles such as What Is a Bitcoin and What Can You Do with It?