Learning Center
Cryptocurrencies and Taxes
Article Highlights:
- Virtual Currency
- Valuation
- Transactions
- Character of the Gain or Loss
- Foreign Currency Transactions
- Foreign Bank and Financial Account (FBAR) Reporting
- Payment for Goods & Services
- Acquiring Virtual Currency
- Virtual Currency Mining
- Employee Payments
- Independent Contractor Payments
Cryptocurrencies are generally utilized for transactions by tech-savvy individuals and have a comparable value in real currency or take the place of real currency. These virtual currencies can be purchased with or exchanged into U.S. dollars, euros, and other real or virtual currencies.
Valuation – The value of a virtual currency is based upon market value, i.e., what a willing buyer will pay a willing seller – much like trading in stocks. On February 15, 2018, when this article was written and according to Oanda (an online currency converter), a Bitcoin, one of the more popular virtual currencies, was worth $9,025, and one was worth $995 one year earlier.
It took several years for the IRS to come up with guidance on how to deal to transactions involving virtual currencies. It finally issued Notice 2014-21 determining that virtual currency is treated as property and that the general tax principles applicable to property transactions apply to transactions using virtual currency. This can best be illustrated by example.
Example B: Taxpayer buys Bitcoin (BTC) as an investment. The same rules apply as for stock transactions. Gains are taxable in the year realized, and any resulting loss, when combined with the other capital transactions for the year, are limited to $3,000 ($1,500 if a married taxpayer filing separate).
Character of the Gain or Loss – The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is held as a capital asset. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that he or she does not hold as a capital asset. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
Foreign Currency Transactions – Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
Foreign Bank and Financial Account (FBAR) Reporting – The IRS has stated a few years ago that virtual currency transactions need not be reported for purposes of Foreign Bank and Financial Account (FBAR) reporting. But the IRS cautioned that its position could change in the future. However, the IRS has not issued any announcements regarding a change in its position on FBAR filings for years through 2017.
Payment for Goods & Services – A taxpayer subject to U.S. taxation who receives virtual currency as payment for goods or services must, in computing gross business income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.
Acquiring Virtual Currency – One can go to online exchanges and purchase virtual currency. But care should be taken to make sure the exchange is reputable. Once you have the virtual currency in your online wallet, you are free to spend it with anyone who accepts that form of currency.
Virtual Currency Mining – Mining is a term used to describe how cryptographic information distributed within a virtual currency network is secured, authorized, and approved. In essence, it is the processing of payments that have taken place once they occur. It takes the place of banks, merchants’ accounts, and clearing houses like Visa. It essentially eliminates all of the third parties’ cuts of income from the transaction. It involves complex mathematical logarithms that need to be solved, and the mining process completes this task autonomously. For individuals who mine virtual currency, it is a trade or business, and they are subject to self-employment tax.
Apparently, virtual currency miners are also subject to Form 1099-K filing requirements if their transactions rise to the reporting threshold. In general, a third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third-party settlement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third-Party Network Transactions. If, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200 and (2) the gross amount of payments made to the merchant exceeds $20,000, then 1099-K filing is required.
Employee Payments – If an employee is paid in virtual currency, then the fair market value of the virtual currency, measured in U.S. dollars, paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax (Social Security and Medicare A), and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement. The U.S. government doesn’t accept virtual currency for tax payments.
Independent Contractor Payments – The fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income to the independent contractor and is subject to the self-employment tax. Payments are subject to the normal 1099-MISC reporting requirement when the payments for the year measured in U.S. dollars are $600 or more.
IRS Enforcement Actions – Because fewer than 900 taxpayers reported virtual currency gains and losses each year on their tax returns from 2013 to 2015, the IRS is stepping up enforcement of the rules. Recently, the IRS won a court’s approval for a summons to obtain account and transaction information on more than 14,000 customers from Coinbase, a company that services buyers and sellers of Bitcoins. Based on the success in the Coinbase case, the IRS will likely expand its efforts to obtain information about cryptocurrency account owners from other companies dealing in Bitcoins and similar virtual currencies.
Also, beginning with 2018 returns, Sec. 1031 tax-deferred exchanges will only apply to real property; thus, investors in virtual currency who trade one type of virtual currency for another will be required to report their capital gains/losses and won’t be able to use the 1031 tax-deferral rules.
If you are investing, trading, or dealing in virtual currency and have any questions about how those activities will affect your tax situation, please give this office a call.
NEVER MISS A STORY.
Sign up for our newsletters and get our articles delivered right to your inbox.
Rose Tax & Financial
Cedar Crest, New Mexico 87008
Sat: 10:00am to 2:00pm
Check the background of your financial professional on FINRA's BrokerCheck
Avantax affiliated Financial Professionals may only conduct business with residents of the states for which they are properly registered. Please note that not all of the investments and services mentioned are available in every state. Securities offered through Avantax Investment Services℠, Member FINRA, SIPC, Investment Advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 3200 Olympus Blvd., Suite 100, Dallas, TX 75019. 972-870-6000.
The Avantax family of companies exclusively provide financial products and services through its financial representatives. Although Avantax Wealth Management® does not provide or supervise tax or accounting services, Avantax representatives may offer these services through their independent outside business. Content, links, and some material within this website may have been created by a third party for use by an Avantax affiliated representative. This content is for educational and informational purposes only and does not represent the views and opinions of Avantax Wealth Management® or its subsidiaries. Avantax Wealth Management® is not responsible for and does not control, adopt, or endorse any content contained on any third party website.
This information is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
The information being provided is strictly as a courtesy. When you link to any of the web sites provided here, you are leaving this web site. We make no representation as to the completeness or accuracy of information provided at these web sites. Nor is the company liable for any direct or indirect technical or system issues or any consequences.
For Important Information and Form CRS please visit https://www.avantax.com/disclosures.