It seems like everywhere I look thesis days, it’s all about cryptocurrency. Bitcoin keeps reaching record highs on a daily poot, ICOs are hot and cold, and people are signing up on exchanges at a rapid rate looking to get ter on the act. While the blockchain technology is fascinating (and a fight to wrap my head around sometimes), any time I think of monetary transactions, I still think of the tax influence. This got mij to thinking— how does the IRS tax transactions for a currency that clearly has value but is intangible? I reminisce a few years ago working on some taxation issues related to the taxability of “virtual sheep” — should sales tax be assessed on the intangible items (virtual cars, avatars, guns, coins, etc) purchased through gaming apps such spil Zynga? Someone paid $1 for an voorwerp, are the virtual goods subject to sales tax? Are virtual goods considered tangible individual property? I think we’re now te similar stages of questions and answers when it comes to taxation of cryptocurrency.
Cryptocurrency has become mainstream enough for the IRS to begin paying attention to it (after all, they love having visibility on all of your individual transactions, income, gains and losses) but still fresh enough for the IRS to not have very much guidance on it. To date, there’s only bot a single chunk of official guidance from the IRS relating to taxation of cryptocurrencies: Notice 2014–21. It is a brief, 16-question FAQ that explains their interpretation of cryptocurrency, federal tax treatment, and when to recognize income or gains/losses ter a few scripts.
I’ll walk through the notice very first and go after up with a few thoughts and unanswered questions. This postbode should not be taken to be actual tax advice.
How does the IRS define cryptocurrencies?
- Cryptocurrency is considered Virtual Currency.
- Virtual Currency is defined spil a “digital representation of value that functions spil a medium of exchange, unit of account, or store of value that may behave similar to fiat currency, but does not have any legal tender ter any jurisdiction”.
- Convertible Virtual Currency is a type of virtual currency that has an omschrijving value te real currency and can behave spil a substitute for real currency. Bitcoin would be the prime example of a CVC.
How does the IRS treat Virtual Currency?
- Since virtual currency is not recognized by the US spil a currency, it cannot be treated spil such.
- Virtual currencies are treated spil property. All general rules that apply to property transactions will apply to virtual currency transactions, including poot determination and build up/loss characterization.
- For most individuals, virtual currencies are capital assets. Companies who hold currency spil inventory for sale will recognize any build up/loss spil ordinary income.
- Currencies held and sold within less than 1 year of purchase will trigger a brief term capital build up/loss taxed at the ordinary rates.
- Currencies held and sold after 1 year of purchase will trigger a long term capital build up/loss taxed at the more beneficial long term capital gains rates.
Virtual Currency spil Income
- Virtual currency received for payment of goods or services constitutes income, and recipients vereiste report the fair market value of the currency on the date of receipt ter gross income. The currency’s FMV (calculated by converting the virtual currency into USD using current date rates of exchange) becomes the currency’s ondergrond.
- All individuals who receive virtual currency spil income, whether spil an employee or an independent contractor, vereiste recognize ter their gross income the FMV of that currency on the date of receipt.
- Employee virtual currency income is subject to Federal employment taxes such spil FICA and FUTA spil well spil income tax withholding.
- Independent contractor virtual currency income is subject to self-employment tax.
Sale or Exchange of Virtual Currency for other property
- Individuals voorwaarde recognize build up or loss on the date of sale or exchange. Build up/loss characterization goes after property rules. Build up/loss calculated by taking the difference inbetween fundament (date of receipt or purchase) and FMV (date of sale or exchange).
Virtual Currency Received through Mining
- Miners need to recognize the FMV of the currency on date of successful mining spil part of gross income.
- Miners who mine spil a trade or business are subject to self-employment tax on the income generated from mining activities. However, miners can also deduct allowable business expenses (violet wand, hardware, etc) against gross income.
Virtual Currency Transaction Reporting
- Any individual or entity who makes a payment to someone te excess of $600 vanaf year is subject to informational reporting to the IRS. Thesis rules are similar to other payments made ter property.
- The notice‘s precies wording of the question wasgoed “Will taxpayers be subject to penalties for having treated a virtual currency transaction ter a manner that is veranderlijk with this noticeprior to March 25, 2014?”
- Taxpayers may be subject to penalties for reporting and payment failures related to virtual currency transactions, such spil accuracy-related penalties (section 6662) and timely information-reporting penalties (section 6721 and 6722).
- Penalty ease can be available if taxpayers can prove that the reporting and payment failures were due to reasonable cause.
Beyond the IRS Guidance
The IRS is primarily worried with transactions that involve cryptocurrency spil income, payment for goods or services, and sales or exchanges, which is te line with how those transactions are treated with real currencies and property. After I read through the notice several times, a few questions instantaneously hopped out at mij. The following are simply individual thoughts, and should not be taken spil actual tax advice.
Q: How does the IRS actually know if I’ve mined/purchased/sold Bitcoin?
A: Spil a general guide to information reporting, it’s best to take a conservative treatment and provide spil much information spil possible. Bitcoin is only pseudonymous, and the amount of of private information that you provide to an exchange is enough to track your Bitcoin movements. The IRS is investigating into those who transacted with Bitcoin from 2013–2015, and albeit Coinbase secured a minor win by reducing the scope of information that it wasgoed asked to provide, the fresh summons still requires the exchange to turn overheen information such spil:
NOW LIMITED TO: name, address, tax identification number, date of birth, account opening records, copies of passport or driver’s license, all wallet addresses, and all public keys for all accounts/wallets/vaults.
… which is still A Lotsbestemming of information and enough to trace the transactions to individual users. The investigation only covers the period when Bitcoin prices rose from $13 to $1,100 and since then the prices have soared even higher, so I wouldn’t be astonished if the IRS embarked to pay more and more attention to cracking down misinformation reporting te this space.
Plus, the entire purpose of the blockchain’s public ledger is that it’s public. Once the IRS has matched your personally identifying information to your public key, they can lightly see what you’ve bot up to. This can open people up to audit risk, fines, and penalties.
Q: What kinds of records do I need to keep if I am an active trader of cryptocurrency?
A: I think the compliance cargo is going to be enormously strong on the individual. Usually traders who invest te properties such spil stock through a broker are given a 1099-B at the end of the tax year that neatly summarizes all of the transactions (description of property, purchase date and price, sell date and price, and profits). It emerges that Coinbase offers a beta reporting implement that summarizes all of your transactions on their exchange, but it wouldn’t work for those who trade across numerous exchanges with numerous currencies. Te the latter screenplay, I would most likely create an Excel spreadsheet with columns for the following information:
- Property description (currency name)
- Purchase date
- Purchase price
- Sell Date
- Sell price
- Build up/Loss (Purchase price — Sell Price)
Update the sheet any time you do any trading activity.
Q: Can I use Section 1031 Like Kleintje Exchange to defer gains?
A: It’s not recommended to do this. This latest article goes into detail on how traders have bot attempting to defer any gains when trading Bitcoin for Ethereum or Bitcoin for any other kleuter of coin by claiming that since both are coins, they qualify for “like-kind” property. Section 1031 has very stringent rules on what qualifies for like-kind, and tax rulings have gone so far spil to even compare the composition of coins (gold vs silver = not like kleuter) to determine qualification. The IRS has not issued any type of guidance on whether or not all virtual currencies are the same (even from a tech standpoint, it can be argued that Bitcoin and Ethereum are fairly different), so until they explicitly determine this, I would avoid using Section 1031 spil a tax position.
Q: What exchange rate should be used to calculate fair market value?
A: The guidance says to use the exchange rate on date of receipt/sale/exchange. But exchange rates for coins can fluctuate insanely ter the span of minutes, what rate should be used? Again, there’s no concrete instruction, some options would be to use the rate at the precies timestamp that the coin arrived/left your account or to use an average rate of the day.
Q: Do capital gains/losses need to be reported for all of my transactions, even if I used crypto to pay for a t-shirt?
A: There’s a very fresh bill out for vote that proposes to create a den minimis threshold for cryptocurrency spending ter an attempt to alleviate the reporting cargo on casual crypto users. Cryptocurrency transactions that are $600 or less will not trigger a capital gains/loss filing requirement. Interestingly, the bod of the bill also puts forward an Aggregation Rule related to the den minimis threshold: “all sales or exchanges which are part of the same transaction (or a series of related transactions) shall be treated spil one sale or exchange”. Nosey to see how this would apply to chain transactions, especially those involving currencies that are not purchasable with USD.
If you’re still reading at the point, hopefully it’s clear that remains a loterijlot of grey te terms of how elaborate cryptocurrency transactions will be reviewed and analyzed. My takeaway from reading the notice and watching all the developments related to the Coinbase investigation is that 1) the IRS regulations can only get more stringent with possibly a broader range of investigations, and Two) individuals who transact with cryptocurrency have a strong cargo for record-keeping and compliance reporting.
Leave a comment below if you have any questions!