Cryptocurrency, Bitcoin, And TaxesDid you “throw your hat” in the proverbial “ring” of Cryptocurrency in 2017? If so, you may need to “square up” with Uncle Sam this tax season. The New Year is upon us and many of you that participated in the Cryptocurrency craze are now left wondering how to properly report your transactions to the IRS. Although you may have just learned about Bitcoin and Cryptocurrency recently, it has been around for quite a few years now. In 2014, the IRS released Notice 2014-21 which outlines how the IRS views “virtual currency” and how certain transactions should be treated. The following is a brief summary of key points from this Notice:
Bear in mind that IRS Notices are not law and should be treated as such. While the IRS and Federal Courts generally respect non-legislative IRS pronouncements, they are not legally bound to. Taxpayers should consult a tax professional before making a final determination regarding Cryptocurrency transactions.
CRYPTOCURRENCY CONSIDERED PROPERTY
Bitcoin and other Cryptocurrencies are considered property in the eyes of the IRS. This means that anytime Cryptocurrency is sold or exchanged, the seller is going to have either a gain or a loss (whether ordinary or capital depends on if the Cryptocurrency is held as a capital asset or not). This determination also means that Cryptocurrency is not actually considered currency to the IRS. Foreign currency gains or losses do not apply to “virtual currency.”
BASIS IN CRYPTOCURRENCY
One’s basis in Cryptocurrency held is equal to the fair market value of the “virtual currency” – in U.S. Dollars – on the date of receipt.
FAIR MARKET VALUE
The fair market value of Cryptocurrency can be determined by the price listed on applicable exchanges. This assumes that the prices listed on the exchange are determined by market supply and demand and a consistent method is used in determining fair market value.
CAPITAL VS. ORDINARY TRANSACTIONS
Determining whether a Cryptocurrency disposition constitutes a capital transaction or an ordinary transaction is of utmost importance given that capital transactions can be taxed at preferential rates (if a long-term holding period applies). In general, Cryptocurrency transactions will only be treated as capital transactions if the property is held as investment much like one would hold stocks and bonds.
Ordinary and capital transactions are both taxed at ordinary rates if the Cryptocurrency was held for one year or less so the classification of the transaction is relatively inconsequential. Taxpayers that have sold or exchanged Cryptocurrencies that have been held for more than one year should seek guidance from a tax professional to determine if their gain or loss is capital or ordinary in nature (it matters!).
Those that “mine” Cryptocurrency have income equal to the fair market value of the Cryptocurrency (in U.S. Dollars) on the date received. In addition, if the taxpayers’ mining activity constitutes a trade or business – which it generally would – the Cryptocurrency income is subject to self-employment taxes and will be reported on Schedule C. In this case, taxpayers will be allowed to deduct allowable business expenses associated with the mining activity.
CRYPTOCURRENCY AS COMPENSATION
Independent Contractors: If an independent contractor receives payment in Cryptocurrency, the contractor has self-employment income equal to the fair market value of the Cryptocurrency on the date received. As mentioned above, the independent contractor can deduct allowable businesses expenses against this income.
Employees: Employers can pay their employees wages in Cryptocurrency. The wages will be reported as W-2 wages and the payments will be subject to federal income tax withholding and payroll taxes.