Some clients have made record profits for the 2022 financial year (ending 31 March 2022). But, they have since had significant losses after the recent market downturn (in the 2023 financial year).
The 2023 loss cannot be offset against the prior-year (2022) profit.
A loss was previously able to be offset against a prior-year profit for 2020 and 2021 because of special covid tax legislation. The government mentioned that this legislation might be extended; however, it hasn’t been.
Instead, 2023 losses are carried forward. They can be used to offset future profits or other income and will continue to be carried forward until utilised.
We have discussed this with IRD, and the only saving hope would be a change to tax legislation. This is extremely unlikely before the 2022 filing deadline.
John makes a profit of $1m for the YE 31 March 2022. This could result in a 2022 tax liability of $390k (39%). For simplicity, assume John invested $100k of his capital, and on 31 March 2022, the closing stock of his cryptocurrency was valued at $1.1m (hence the $1m profit).
Instead of cashing out to pay his tax, John leaves his cryptocurrency invested in the market, expecting it to increase further.
Due to the recent market downturn, his $1.1m portfolio could now only be worth $390k. John sells his cryptocurrency for a $710k loss in the 2023 financial year. From the $390k remaining, John pays $390k of tax and has nothing left over.
Unfortunately, this may be the current situation for some taxpayers.
In 2023, John will have a loss of $710k (assume no other income for simplicity).
In 2024, John has a loss of $710k and receives an employment income of $120k. His employment income has PAYE deducted $30,520* throughout the year from his employer. Because of the loss carried forward, John will receive a tax refund of $30,520 and continue to have a loss to carry forward of $590k ($710k less $120k).
John can earn a further $590k of income without having to pay any income tax (due to the losses carried forward from the crypto loss).
*Note, if this were our client, we would apply for a special PAYE deduction rate of 0%, so no PAYE was deducted during the year. Therefore, John would receive more cash (net wages paid) during the year rather than waiting until the end of the year for a tax refund of the PAYE deducted.
Plan for how you are going to pay tax on cryptocurrency profits. It’s unlikely most taxpayers would borrow money to buy cryptocurrency. Yet, in the example above, John leveraged his tax funds by keeping them invested in cryptocurrency and subject to price volatility.
Have a cryptocurrency investment strategy. The $1m gain is only taxable to John (in 2022) if he has realised the gains. If he brought in 2019, and the $1m gain was unrealised, it would not be taxable, and he wouldn’t have any tax to pay (he’d be 39% better off).
Understand how cryptocurrency taxes work. Every transaction is a taxable event that must be captured for accounting and tax purposes. It’s effortless to trade cryptocurrency back and forth on multiple exchanges using various tokens and defi platforms. Back-end accounting and record-keeping systems aren’t established to capture these transactions simply and efficiently. It’s a dog’s breakfast to try and follow complicated trading activity. Is your level of activity needed?
Consider the psychology behind making decisions. We’ve outlined some comments from recent conversations with clients in this article.
Losses in Companies or Trusts
In John’s example above, the profits and losses are taxed in his capacity because he owned the cryptocurrency in his name. An individual can likely earn income from non-crypto sources (employment income), and therefore, losses carried forward can be utilised against the other future income.
If a company or trust owns cryptocurrency, and that capital is eroded from losses, it may be difficult for the company or trust to earn future income. There is no capital available for future investment to earn an income. Therefore, the company/trust will have a loss to carry forward but limited future income to offset the losses. This results in the losses being ring-fenced inside the entity.
For example, using the same outcome as the earlier example, except ABC Company Limited (ABC Company) owns the cryptocurrency instead of John.
ABC Company has a profit of $1m for the YE 31 March 2022 and a tax liability of $280k (28% tax rate). The portfolio is worth $390k, and ABC Company sells for a $710k loss. ABC Company has a 2023 loss of $710k which is available to offset future company income.
However, ABC Company has no assets invested to earn income. Therefore, utilising the $710k of losses carried forward may be challenging.
Contact Tim Doyle for a call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.