While ‘Tax Season’ may traditionally be from January 1st through April 15th for most individuals, it is a year-round consideration for those who hold and transact cryptocurrency assets. Internal Revenue Service (“IRS“) Notice 2014-21 (the “Notice“) is an important guidance for those in the crypto and digital currency space, especially when it comes to reporting profits.
Under the Commodity Futures Trading Commission’s (“CFTC“) regulations, American resident tax payers are required to report worldwide crypto trading to the IRS, whether or not those funds will be repatriated to the United States.
Forms of Virtual Currency
The Notice defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Virtual currency differs from traditional fiat or physical currency (coin and paper money) in that it is not the legal tender of a country. Further, “virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.”
With Bitcoin’s exponential value increase from February 2017 through December 2017, there are likely new crypto holders that will have to log their gains/losses for the first time.
The Notice states that “virtual currency is treated as property. [Thus], general tax principles applicable to property transactions apply to transactions using virtual currency.” In this way:
Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes;
Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099;
The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer; and,
A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
The character of the gain/loss of the virtual currency is dependent upon whether it is considered a capital asset. The IRS defines capital assets as, “almost everything [owned and used] for personal or investment purposes.” Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments. When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss.” This means that Bitcoin receives capital gain and loss treatment because it is held as a capital asset. The Financial Industry Regulatory Authority, (“FINRA“) provides a cost basis overview here to determine how such gains/losses are to be reported.
Frequently Asked Questions (“FAQs“)
I bought some items/services using Bitcoin, do I have to report these? Yes.
I was paid using Bitcoin, are there tax consequences?
It is taxable to the employee and must be reported on the W-2. Similarly, independent contractors must treat payment via digital currency as gross income and subsequently pay self-employment taxes.
I paid someone in Bitcoin, do I have to report this? Yes.
I sold Bitcoin last year, what do I need to do?
Depending on how long you held the crypto, you may qualify for differing long-term capital gains rates. Short term digital assets that are held for one year or less are taxed similar to your ordinary income.
How do I report my virtual currency transactions?