In recent years, Bitcoin and many rival cryptocurrency types have all experienced record-breaking growth, leaving many investors and their CPAs struggling with confusion and surprise during tax season. Bitcoin and several rival forms of cryptocurrency have all experienced record-breaking growth in recent years, leaving many investors and their CPAs to grapple with uncertainty and surprise during the tax season. Many returns have been extended, awaiting further guidance from the IRS, while other taxpayers have been confronted with an unexpectedly large tax bill as a result of misconceptions about how such transactions are taxed.
What is Cryptocurrency?
Cryptocurrency is a digital currency that uses encryption techniques rather than a central bank to generate, exchange and transfer currency units. Unlike cash transactions, no bank or government authority shall verify the transfer of funds. Instead, these virtual transactions are recorded in a digitized public ledger called a blockchain. The individual currency units are called “coins.”
Introduced in 2009, Bitcoin was the first cryptocurrency and is still the most widely used. Since then, other forms have grown tremendously in popularity, including Ethereum, Litecoin, and Ripple. While cryptocurrency exchanges have experienced market booms and busts, experts predict that the use of cryptocurrency will continue to increase, making it imperative that CPAs be prepared to understand and educate their clients about the tax implications of these virtual transactions.
IRS Treatment of Cryptocurrency
The IRS addressed the taxation of cryptocurrency transactions in Notice 2014-21, which provides that In Notice 2014-21, the IRS highlighted the taxation of cryptocurrency transactions, which provides that cryptocurrency is treated as property for federal tax purposes. The general tax principles applicable to property transactions must therefore also apply to exchanges of cryptocurrencies. Notice 2014-21 provides that taxpayers must recognize gains or losses on the exchange of cryptocurrency for cash or other property. Gain or loss is therefore recognized every time cryptocurrency is sold or used to purchase goods or services. How the gain or loss is recognized depends largely on the type of transaction performed and the duration the position was held.
When Do You Have to Pay Taxes on Crypto?
Did you Settled for cash?
Cryptocurrency benefits from trading coins held as capital assets are treated as investment income by the IRS and are subject to the same rules on capital gains. A taxpayer who sells a coin position in cash must report a capital gain on Form 8949. A coin position held for one year or less is considered to be a short-term capital gain, taxed at ordinary tax rates; a position held for more than one year is considered to be a long-term capital gain.
As with stock trades, capital losses offset capital gains in full and net capital losses are limited to $3,000 ($1,500 for married taxpayers filing separately) against other income types on an individual tax return. The excess capital loss shall be carried forward to the following tax year.
Crypto used to pay for goods and services taxed as income
If you are a Bitcoin paying employer or contractor, you must report employee earnings on W-2 forms to the IRS.
You must convert the value of the Bitcoin to U.S. dollars as of the date of each payment and keep a careful record.
Wages paid in virtual currency are subject to withholding to the same extent as dollar wages.
Employees, even though earned as Bitcoin, must record their gross W-2 compensation in dollars. As of the day earned, self-employed persons with Bitcoin profits or losses from sales transactions must also convert the virtual currency to dollars and record the figures on their tax returns.
Bitcoins held as capital assets are taxed as property
You must treat them as property for tax purposes, if Bitcoin is kept as a capital asset. General tax rules related to transactions relating to property are applicable. Any gain or loss from the sale or exchange of an asset, including stocks or bonds, is taxed as a capital gain or loss. Otherwise, ordinary profit or loss on an exchange is realized by the investor.
Bitcoin miners must report receipt of the virtual currency as income
By using computer resources to verify Bitcoin transactions and manage the public Bitcoin transaction ledger, some people “mine” cryptocurrency.
According to the IRS, after deciding the fair market dollar value of the virtual currency as of the day you earned it, if a taxpayer successfully ‘mines’ Bitcoin and has profits from that transaction, whether in the form of Bitcoin or some other form, he or she must include it in his gross revenue. If a cryptocurrency miner is self-employed, the self-employment tax is also subject to his or her gross earnings minus allowable tax deductions.
Tax Implications and Reporting Requirements
In order to track the basis of each bitcoin, the tax consequences of using crypto which appear close to stock shares or stocks in that records need to be maintained; however, wash transactions are likely not applicable to bitcoins as they do not follow the concept of a stock share.
In addition to keeping monitoring records, taxpayers should also be mindful that cryptocurrency represent self-employment profits and are thus subject to self-employment tax if they are paid for their services with crypto.
In addition, if the amount is $600 or more to a non-exempt recipient, a person who makes a payment using virtual currency in the course of a trade or company may have a Form 1099-MISC reporting obligation. Backup withholding may also apply.
A bill to create tax exemptions for crypto-currency transactions under $600 has recently been introduced in the House of Representatives. Although this can provide greater flexibility for certain transactions, to circumvent disclosure requirements, it may also create issues with disclosures or structuring transactions.
How to be Crypto Compliant and Stay Clear of Tax Problems
Cryptocurrency appears to be here for the long term and therefore the scrutiny around its reporting will continue to intensify. It needs CPAs to keep up with the changing regulatory image surrounding this new form of asset, particularly those whose customers hold positions in one or more cryptocurrencies.
Did you know that cryptocurrency sold or traded within one year of ownership is subject to greater tax rate? This is the kind of advice that tax professionals can give. Tax advisors can help you with crypto tax planning and much more.
Gamburg CPA is experienced with cryptocurrency taxation. Businesses and individuals alike have come to trust us with filing their taxes because we are well versed in cryptocurrency tax rules and regulations. We know how to precisely prepare and file your tax returns in line with the most current laws governing cryptocurrency, so that you avoid penalties, don’t get into trouble with the IRS, and keep more money in your pocket.