Fundamentals: Capital Gains & Ordinary Income

Accounting For Crypto Assets

Most income is taxed in three different ways, and taxpayers can make decisions that affect that classification. Understanding the tax classification of earned and asset-based income is essential to minimize taxes. Income is classified as:

Long-term capital gains (capital assets held more than a year)

Short-term capital gains (capital assets held one year or less)

Ordinary income (income earned by wages, salaries, tips, commissions, interest, income earned from a business or through self-employment, and non-qualified dividends)

Long-term capital gains (LTCGs) usually have the most favorable tax rates; tax brackets in 2022 for individual taxpayers and companies are 0%, 15%, or 20%. Short-term capital gains (STCGs) are subject to taxation as ordinary income at the marginal tax rate for individuals of as high as 37% and corporations of up to 21% in 2022. Gains and losses are also subject to netting by type. All short-term gains and losses are combined to determine the net short-term gain or loss, and all long-term gains and losses are combined to determine the taxpayer’s long-term gain or loss. The IRS allows individuals to deduct only $3,000 of any excess capital loss from your income each year (or up to $1,500 if you're married filing separately) with any remaining loss being carried forward to future years. Note that businesses may be able to carry Net Operating Losses (NOLs) forward to offset a portion of future business income. Also, if a significant portion of your income is from investment, you may be subject to an additional 3.8% Net Investment Income Tax as provided by IRC 1411. A great explanation of this may be found on the IRS’s website where they provide a Q&A related to NIIT: https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax