Donut is such a unique investment tool that it leaves many people wondering whether the Donut app is legit. That also means there isn’t much information available about paying taxes on Donut earnings. Here’s what you should know.
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This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.
How does the Donut App work?
With the Donut App, you invest and withdraw traditional U.S. dollars. The app invests in cryptocurrency and pays you interest. The interest is also in traditional dollars.
The setup is similar to a bank account where the bank makes money off of your deposits and pays you interest to encourage deposits. Of course, Donut is not FDIC insured, is not a bank product, and could lose money.
This post isn’t about whether you should or shouldn’t use Donut. It just explains how the taxes work if you did invest in Donut or are thinking about it.
Are Donut earnings interest or capital gains?
Donut earnings should generally be treated as interest. That’s because of how you make money.
You’re lending your money to Donut, and Donut is then lending money or Ethereum to other people. While you have a risk of losing money, in theory, you’re supposed to get 100% of your investment back unless something goes wrong. You also don’t have a chance of increasing your investment — Donut keeps any gains over the interest.
Since you’re getting a regular payment at a fixed rate, the income from Donut counts as interest.
Capital gains are for when you buy and sell an asset. When the IRS says cryptocurrency is property, it’s talking about people who buy and sell coins.
When you buy Ethereum and sell it at a higher price, you have to pay capital gains taxes. The difference with Donut is that you’re not buying and selling — you’re lending to someone else.
This is similar to how bank deposits work. If you deposit money that the bank uses to issue mortgages, you don’t pay capital gains taxes just because the mortgage might be used to buy real property.
You aren’t the one buying the property. You’re lending and getting interest.
Do Donut users need to check the Form 1040 box that says “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”
Donut users generally don’t need to check the cryptocurrency box on 1040. According to IRS guidelines, you don’t need to check the box if you:
- Purchase virtual currency using real currency, including purchases using real currency electronic platforms such as PayPal and Venmo.
- Hold virtual currency in your own wallet or account.
More fundamentally, you can also say you’re not actually purchasing or holding the cryptocurrency. You invest dollars, get interest in dollars, and take out your original dollars.
That’s also why you don’t have to check the cryptocurrency box for receiving virtual currency as payment or for selling virtual currency. You’re not receiving virtual currency, and you’re also not selling it.
Does Donut issue tax forms?
Donut does not issue tax forms. I’m really not sure why they seem to think they’re exempt from doing so.
They do provide instructions for creating your own Form 1099-INT to enter on your tax software.
- Add up your interest payments during the year using your account statements or tax summary in your app.
- Enter the Donut address Donut, Inc., 6121 Sunset Boulevard, Los Angeles, CA 90028, United States
- Enter the Donut TIN/EIN 61-1929355.
If you’re not using tax software that asks for your 1099-INTs, you can enter the interest on Schedule B.
Why do I have to pay taxes if I didn’t get a tax form?
The IRS requires you to report all income even if you don’t get a 1099. Getting a 1099 isn’t what makes your income taxable.
The IRS uses 1099s to help find out who isn’t reporting their taxes. However, even if you’re under the minimum income to get a 1099 or a business doesn’t issue a 1099 when they should, you still have to report your income.