Everyone is talking about cryptocurrency such as Bitcoin, Litecoin, and Ethereum. Cryptocurrencies have become popular alternatives for online payments. Before converting real dollars into cryptocurrency, understand that there are real risks in using cryptocurrencies which is why I am not a fan.

A cryptocurrency is a digital currency, an alternative form of payment created using encryption algorithms. The use of encryption technologies means that cryptocurrencies function both as a currency and as a virtual accounting system. To use cryptocurrencies, you need a cryptocurrency wallet. These wallets can be software that is a cloud-based service or is stored on your computer or on your mobile device.

What are the risks to using cryptocurrency? The market for these digital currencies is very volatile. Since cryptocurrencies don’t need banks or any other third party to regulate them, they are usually uninsured and hard to convert into a form of tangible currency. In addition, since cryptocurrencies are technology-based intangible assets, they can be hacked like any other intangible technology asset. Finally, since you store your cryptocurrencies in a digital wallet, if you lose your wallet, you have lost your entire cryptocurrency investment.

Like just about everything else in finance, crypto saw its prices tank when the Federal Reserve started to raise interest rates to fight rising inflation.

That caught bitcoin’s biggest backers by surprise, many of whom believed the virtual currency would be an inflation hedge, like precious metals. They had predicted bitcoin’s value would rise during a period of high inflation; instead, it was falling.

Generally, the IRS taxes cryptocurrency like property and investments, not currency. This means all transactions, from selling coins to using cryptos for purchases, are subject to the same tax treatment as other capital gains and losses.

Because of this, long-term crypto investors have a valuable opportunity: If they hold onto their coins for at least a year, they can benefit from lower long-term capital gains taxes, which range from 0% to 20%, depending on your income level. Short-term crypto gains on purchases held for less than a year are subject to the same tax rates you pay on all other income: 10% to 37% for the 2022-2023 tax filing season, depending on your tax bracket.

These taxes apply even if you use crypto to make purchases, meaning you may be on the hook for sales tax plus taxes on any gains your crypto has made since you first bought or received it.

You may also owe taxes on crypto if you earn it by mining cryptocurrency or receive it in exchange for goods and services. In these instances, it’s taxed at your ordinary income tax rates, based on the value of the crypto on the day you receive it. (You may owe taxes if you later sell the crypto you mined or received at a profit.) 

If all of your crypto transactions occur on one exchange, then, gathering the information you need to report cryptocurrency on your tax return should be easy. If you have crypto transactions across several exchanges, however, things may get more complicated. You’ll need to get a report from each place a transaction occurred or track the transactions yourself.

After you’ve collected all of your crypto transactions, you must report them to the IRS on Form 8949. This form is divided into two sections: short term (for crypto held one year or less) and long term (for crypto held longer than one year).

Recently, the Office of Chief Counsel advised that a taxpayer, who purchased for personal investment cryptocurrency in 2022 for $1 per unit that declined in value to less than one cent per unit at the end of 2022, did not sustain a loss under Code Sec. 165. According to the Chief Counsel’s Office, the taxpayer did not abandon or otherwise dispose of the cryptocurrency and the cryptocurrency was not worthless because it still had value; further, even if the taxpayer sustained a loss under Code Sec. 165, the loss would be disallowed because, under Code Sec. 67(g), miscellaneous itemized deductions were suspended for tax years 2018 through 2025. CCM 202302011.

But it only gets worse. The Office of Chief Counsel also advised that, when a taxpayer donates cryptocurrency for which a charitable contribution deduction of more than $5,000 is claimed, a qualified appraisal is required under Code Sec. 170(f)(11)(C) in order to obtain a charitable contribution deduction. Further, the Chief Counsel’s Office concluded that if a taxpayer determines the value of the donated cryptocurrency based on the value reported by a cryptocurrency exchange on which the cryptocurrency is traded rather than by obtaining a qualified appraisal, the reasonable cause exception in Code Sec. 170(f)(11)(A)(ii)(II) will not excuse noncompliance with the qualified appraisal requirement and the charitable contribution deduction will be disallowed. CCM 202302012.

As I said, I’m not a fan of cryptocurrency.

Regarding grandparents, the fact that they are grandparents, does not, in and of itself result in any tax benefits.  However, there are certain tax provisions that may apply.  First, any amounts given by a grandparent is usually considered a gift.  Beginning in 2022, the annual exclusion increased from $15,000 to $16,000.  Gifts to one person in excess of the annual exclusion require the filing of a gift tax return, although no gift tax is incurred because the gift tax credit is so large. Married grandparents can join together to give one grandchild $32,000 each year.

Grandparents can establish a Section 529 plan for a grandchild and possibly save state income tax in the state where the grandparent resides, depending on state law.  Maryland and DC, for example, give the donor a deduction for money contributed to their state’s Sec 529 plan. A grandparent who is married can deposit $160,000 into their grandchild’s 529 plan to cover K-12 expenses—an amount equivalent to a $32,000 contribution each year over five years. When filling out their federal tax forms, they can elect to include this gift over a five-year period (i.e., $32,000 x 5 = $160,000), thereby excluding the $160,000 from any gift taxes.

Assuming the grandparents live five more years, the entire $160,000, plus the money earned from this investment, will not be taxed as part of their estate. And after this five-year period elapses, they can deposit an additional $160,000. Grandparents should be sure to consult their tax advisor before making large deposits into a 529 plan.

Here’s another opportunity.  At age 72, IRA owners must start taking money – known as Required Minimum Distributions (RMD) –  from their retirement accounts.  Even if the person doesn’t need the RMD money, IRS still requires the distribution which is taxable.

If the grandparent contributes their RMD to a grandchild’s 529 account, the grandparent will still pay income tax on the RMD, but the money they invest in the 529 account will grow tax-deferred. And if the money is later used for qualified education expenses, the entire amount is available to the student tax-free.  Additionally, the amount contributed by the grandparent to a 529 account is not included in their estate for estate tax purposes — even though they retain control over the funds.  When applying for financial aid for college, by setting up a 529 account in the name of the grandparent with a grandchild as a beneficiary, these assets are not included as either the child or parent’s assets.

Finally, a grandparent can pay for college tuition. A special tax-code exemption allows a grandparent to pay college tuition and not have that money subjected to gift tax. The IRS makes an exclusion in the case of financial gifts used for tuition payments.

The exclusion, called the Gift Tax Education Exclusion for Tuition, means that money gifted to a friend or family member to pay for college tuition is not subject to the federal gift tax. Under the Internal Revenue Code, you can pay unlimited amounts for someone’s tuition and not be taxed.

To make a tuition gift that qualifies for the federal gift tax educational exclusion, the gift-giver should make the tuition payment directly to the student’s school—they should not give the money to the student.

Paying the school directly, instead of donating to a student’s 529 plan helps grandparents avoid potential gift taxes if they plan to make significant contributions. Of course, it’s not just the grandparent’s finances that must be considered, but also the student’s. Luckily, that is about to get easier.

In the past, grandparents faced issues when trying to pay for their grandchildren’s college tuition. However, with the arrival of the new Free Application for Federal Student Aid (FAFSA), a major change is coming that will be very beneficial.

Those who file the FAFSA will no longer be asked if their grandparents will be providing any assistance. This means that students whose grandparents pay part of their college expenses will no longer see their financial aid decrease, as long as the grandparents know how to properly give the money.