Accelerating and increasing your income can be a good strategy during a bear market. You will pay the taxes sooner, but it may save you significantly in the long run.
Pay Tax Now, Save Later
This next strategy is counterintuitive: actively working to increase your income and generate taxable events sooner rather than later.
That’s the opposite of what you’re often trying to do – especially in a bull market. During bull runs, you’re more likely to be making a lot of money and be in a higher tax bracket. So in those high income years, you’re typically trying to do whatever you can to defer the tax hit.
So how and why would you accelerate your income?
As an example, let’s look at income from Gala Games nodes. Income from these nodes is not taxable until the tokens are actually minted. This will change in the future when Gala moves to its own blockchain (at which point it will become taxable upon receipt, just like mining income and airdrops). But until then, minting is what finalizes your having “dominion and control” over the asset and is what triggers the taxable event. (Reference our guide on the taxation of Gala Games nodes for a much more in-depth discussion on these principles and their application)
So in the majority of cases, you’d want to hold off on minting the tokens to delay the tax hit. But a bear market can be the perfect time to mint them.
Why?
Because it can drastically decrease your taxable income in the future.
There are a few main benefits to minting your tokens now instead of later:
- It will decrease the initial amount of taxable income, since you a minting the tokens at a lower price
- You are generating a taxable event in a year when your income is already down and will possibly be paying a lower tax rate on that income
- When you sell your tokens, more of your income will be taxed as capital gains. And if you hold the tokens for at least a year, you will receive the much more favorable long-term capital gains treatment
How Bear Market Income Saves You Long-Term
This is best illustrated with examples.
“John” and “Steve” both have 1 million Gala tokens that they have mined from their nodes.
John mints his when the token was worth 5 cents. One year later he sells all of his tokens when Gala reaches 60 cents.
Steve waits until Gala is worth 50 cents to mint his tokens. One month later, he also sells all of his tokens at 60 cents.
Both of them have $600,000 of proceeds from the sale of their tokens. But how is it taxed?
On the initial minting, John gets hit with taxable income of $50,000 (1 million tokens x $0.05 mint price). This becomes his cost basis for when he sells his tokens a year later ($600,000 – $50,000) for a $550,000 capital gain.
Steve on the other hand gets hit with $500,000 of income when he mints his tokens (1 million tokens x $0.50 mint price) and when he sells is hit with another $100,000 in capital gains ($600,000 – $500,000).
So both of them generate $600,000 of taxable income ($50,000 + $550,000 and $500,000 + $100,000). No big difference, right?
If only.
Node income is not only considered ordinary income and is taxed at regular income tax rates, it’s also considered business income. Business income is subject to self-employment tax unless you are structured as an S-Corp. (See our article on the taxation of nodes for additional guidance)
So with node income you’re getting hit with:
- Ordinary income tax rates. There is no option for it to be taxed as capital gains
- 15.3% self-employment tax up to the Social Security cap and 2.9% after that cap is hit, unless you’ve got your node income run through a corporation
So Steve has $500,000 of self-employment income. He also didn’t hold his crypto for a year before selling it, so his sale of the tokens is a short-term capital gain and is taxed as ordinary income as well.
John is in a much better situation. He only has $50,000 of node income from his minting. And his $550k from the sale of his tokens all qualify for long-term capital gains treatment.
The Savings of Long-Term Capital Gains
Like every tax situation, exactly how much tax this generates will depend on the taxpayer’s situation: the amount of income and deductions they have from other sources, their filing status, if they have dependents, etc.
But for the ease of this example, we’re going to show this all as income for a single year, even though John’s income would hit in two separate years. We’ll also assume that John and Steve both have no other income or deductions, are single filers, have no children, and did not run their node income through an S-Corp. How much federal tax are they each going to pay?
John is going to pay about $115,000. That’s a lot of money, but on income of $600,000 that’s a pretty good tax rate.
Steve is going to pay closer to $215,000. Nearly double what John paid the exact same amount of income.
That’s not to say that John’s approach is not without risk. If the project had gone belly-up and the token had instead gone to zero – which can and does happen – then he would have $50,000 of phantom income he’d have to pay tax on while Steve wouldn’t have to pay anything.
When Can You Control the Timing of Taxable Events?
Unfortunately, you don’t always have this level of control. Oftentimes, taxable events will occur and you have no control over their timing. In most cases, income is taxable upon receipt. Mining income, staking rewards, interest on crypto deposits – all of those are taxable in real time. You don’t really have the ability to defer or accelerate them.
But sometimes you do. You can choose when you execute trades to buy and sell your crypto. In a bear market we’re often doing this for tax-loss harvesting, but you may also have capital gains. Realizing those gains in a down year is often a viable strategy.
You have a similar level of control on when you enter/exit liquidity pools and wrap/unwrap tokens. If you are taking the stance those are taxable events, you may look at triggering them during a down year.
And the example we gave above is specific to Gala, but it is far from the only project out there that has those dominion and control issues. You need to make sure you understand the mechanics of these projects and are working with a CPA who understands these nuances – otherwise these opportunities will be completely missed.
Make sure you are planning regularly with your CPA during this bear market. While it’s less exciting (and I use the term “exciting” very loosely here) than the immediate benefits you’d see during a bull run, the tax savings can be just as significant.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
