Gas fees are how validators get paid to do work on a PoS blockchain like Ethereum. You, as a user, are liable to pay them. But are they taxed?

As you probably already know, there is no such thing as a ‘free transaction’ in the crypto space. Every time you move a token from one wallet to another, the miners and validators who make that move possible get compensated. There are a few different ways in which this happens, but one of the major ones is through gas fees.

Gas fees is the term that’s used for the amount of ETH you’re required to pay to interact with the Ethereum network. These fees are collected by the blockchain and are used to pay miners who expend energy to verify your transaction. Not only that, but they are also compensated for staking their own ETH to provide the network with a layer of security.

While gas fees are great incentives for miners on ETH, they are every user’s nightmare. Gas fees are calculated based on supply, demand, and traffic on the network; meaning that just like ETH, gas fees are also ever-changing.

How are gas fees calculated? 

The amount of gas required depends on the complexity of the transaction too. For example, a simple, Point A to Point B, transaction could cost less gas compared to a token swap or a smart contract.

The most important concept to get your head around, however, is gwei. The cost of gas would be too complicated to calculate in ETH, so a smaller unit, the gwei, is used instead. 

1 gwei = 0.000000001 ETH. A gas fee of 30 gwei, for instance, would be equal to only 0.000000030 ETH.

Gas limits is the maximum amount of work you assume a validator will have to do on a particular transaction. A higher limit typically means that the transaction requires more work, which determines how much you’re willing to pay. Gas price, similarly, is the amount of gwei you do end up paying.

The lower the gas limit any user pays, the lower priority their transaction will be for validators. Hence, if you want a transaction verified sooner, you need to set a higher gas limit.

Dynamism of ETH gas 

An example of how Ethereum gas fees can change based on supply, demand, and transaction type is during periods of high demand, such as when a popular Initial Coin Offering (ICO) is on the way. 

During an ICO, lots of people buy and send ETH to purchase the new token being offered. This creates a high demand for processing power on the Ethereum chain, and gas fees become very expensive. 

For example, during the 2017 CryptoKitties craze, Ethereum gas fees spiked to as high as $6 per transaction due to the high demand for processing power on the network.

On the other hand, during periods of low demand, such as when there are fewer transactions being executed on the network, gas fees tend to be lower. Therefore, it is important for you to  keep an eye on gas fees when making multiple transactions, and adjust them accordingly to minimize costs.

Terminology 

Here are some other terms you should know related to Ethereum gas fees:

• Base fee – This refers to the minimum gwei you’re going to have to spend to include a transaction on the Ethereum blockchain. The base fee is determined by the demand for the transaction at a given point in time regardless of the type of transaction you’re requesting. Base fees are set dynamically throughout the day.

• Tips – This is also known as a priority fee, which gets your transaction processed faster. A tip provides a financial incentive for the validator to confirm your transaction before anyone else’s, which means they get more money and you get your confirmation faster.

How are Ethereum gas fees taxed? 

As you know, cryptocurrency transactions are already taxable in the United States. However, what you might not know is that gas fees are also subject to taxation. Here’s what you need to know about how Ethereum gas fees are taxed in the United States.

Taxation of gas fees 

Gas fees are treated as a cost of doing business on the Ethereum network, and they are therefore deductible on tax returns. Gas fees can be deducted as either a business expense or an investment expense, depending on the purpose of your transaction. They can be broadly divided into two categories:

• Personal transactions: If gas fees are paid for personal transactions, they are not deductible on tax returns. Personal transactions include sending ETH to another person or purchasing goods or services using your tokens.
• Business transactions: If gas fees are paid for business transactions, they can be deducted as a business expense on tax returns. Business transactions include the use of ETH on dApps for business purposes, etc.

Calculating Ethereum gas fees tax liability 

Corresponding to the above, you can only calculate your tax liability after you’ve categorized your transaction into one of these two buckets: personal or business.

If the transaction is business-related, gas fees can be deducted as a business expense under Schedule C of the tax return for sole proprietors or on other appropriate forms for other types of businesses. If the transaction was personal, then no deduction can be made. However, these personal transactions can be reported as an investment expense on Schedule A of your tax returns.

For example, if your business pays $1,000 in gas fees to execute smart contracts, the business can deduct the $1,000 as a business expense on its tax return. If the business is subject to a 21% tax rate, it would save $210 in taxes.

However, if you find yourself in a particularly tricky situation with your taxes, we encourage you to consult a professional because the IRS has not (yet) provided specific guidance on how to calculate tax liability for gas fees.

Reporting gas fees on tax returns 

To report gas fees on tax returns, you must keep accurate records of all ETH transactions. This includes the amount of token used, the purpose of the transaction, and the gas fees paid. It’s important to keep detailed records of Ethereum transactions to ensure accurate reporting on your tax returns.

Note: Gas fees are also subject to the same tax rates as other business expenses or investment expenses, depending on how they are reported on the tax return.

Conclusion 

While gas fees might seem like just an added cost on your ETH transaction, they’re actually one of the main reasons why the network exists today. By incentivising miners and validators to keep staking their ETH and verifying transactions, you and I keep the network running in some small yet significant fashion.