Cryptocurrency and U.S. Income TaxesThe IRS issued guidance on cryptocurrency (virtual currency or digital currency) back in 2014 and this guidance has tax implications that I will address here without getting into any political issues.
My clients that have cryptocurrencies want to know what are the tax implications. To make it complicated, or seem complicated, they acquire and use cryptocurrencies through transactions for goods and services. They also acquire and use them by buying, selling, and trading (trading between different cryptocurrencies).
Tax ConsequencesThe guidance from the IRS is that cryptocurrencies are consider property rather currency for federal tax purposes. The implications are that receipt of cryptocurrencies for exchange of goods and services are consider revenue to the seller and potentially an expense for the buyer if it is for business use. So the recipient must report the value at the time of the transaction in U.S. dollars as revenue in the case of a business or as wage income in the case of an employee. The use of cryptocurrency held that has changed in value is also required to be reported as investment income.
Additionally these payments are subject to reporting requirements. Payments to a business (independent contractor or other service provider) may have to be reported on a 1099-MISC. Wages paid to an employee must be reported by the employer on a Form W-2. Third parties who settle payments made in cryptocurrency (virtual currency) on behalf of merchants that accept cryptocurrency from their customers are required to report payments to those merchants on Form 1099-K.
What is the Value
How much income or expense is reported? In other words what is the value of the transaction? The concept is similar to foreign currency transactions only cryptocurrency is not considered currency for U.S. federal tax purposes. But the reporting of the value is done by the same concept. What was the value in U.S. dollars on the date of the transaction? That is the value that should be the value reported.
So a business or a person may receive payment for goods or services in cryptocurrency and later use those cryptocurrencies. What is the result from a tax standpoint. First, the initial receipt would be based on the value at the time of the transaction. Then, when the cryptocurrency is used to purchase something, is sold for another currency or traded for another cryptocurrency or any other property that results in a taxable transaction. The difference in the value from the date of the transaction using the crytocurrency versus the value on the date it was received would be a taxable transaction likely a capital gain or loss.
For these transactions it will be necessary to track the value of the cryptocurrency received and the date received as well as the value and date on the day of the sale or exchange and any cost incurred in the transactions. This information will be required to report capital gains and losses since crytocurrency is consider property like an investment in gold or silver or other assets. Also, remember to track any costs involved in purchasing or receiving and selling cryptocurrencies.
What about exchanging one crytocurrency for another? It is the same concept as trading gold for silver. Because it is consider property for Federal U.S. purposes the exchange is a taxable event.
Capital Gains are treated differently for long-term and short-term transactions with long-term being for assets held for more than a year and they often receive favorable tax as a result. Therefore, it is imperative to track all transactions involving cryptocurrencies including the information referred to above in "Tracking Value".
Use to Purchase Goods or Services
When cryptocurrencies are used to purchase goods or services this is another reportable transaction for tax purposes. Again, the use of the cryptocurrency would need to reported and potentially be a taxable transaction. Any appreciation or depreciation of the value could result in a capital gain or loss. When the purchase is made using crytocurrency the purchaser would need to establish the value of the cryptocurrency at the time of the transaction. For example, if a product is purchased for so many of the cryptocurrency and would have required so many U.S. dollars to execute the same transaction that would establish the value of the cryptocurrency at the time of the transaction.
First of all, realize that all worldwide income needs to be reported on your U.S. tax return. So even if the transaction is with someone outside the U.S. it is still a reportable and potentially taxable transaction on your U.S. tax returns. This applies even if the transaction is made using property rather than currency. Barter income and revenue received in cryptocurrency is taxable income on your U.S. tax return.
Second, even if you spend the crytocurrency outside the U.S. you will still need the information mentioned above to track and report these transactions on your U.S. federal income tax returns.
Where to reportReceipt of cryptocurrency for your sale of goods or services would be reported as revenue on your business tax returns. Likewise, use of cryptocurrency to purchase goods or services for your business would be reported on your business tax return.
If cryptocurrency is used for personal non business purposes your transactions would be reported on Schedule D of your personal return similar to investment transactions for gold or silver.
As mentioned above, if you receive cryptocurrency for your services as an employee your employer will be required to report that on a W-2 and you will need to report it on your personal tax return like you would any other W-2 income.
Foreign AccountsFor now the IRS has not required the holding of cryptocurrency in a foreign country to be reported as you are required to report foreign financial accounts. This, of course, is subject to change.
Realize you are still required to report income from transactions using cryptocurrencies, just not the amount held in foreign countries as you are required to report the amounts held in foreign financial accounts.
Penalties and InterestKeep in mind that failure to timely report cryptocurrency transactions on your tax returns can result in penalties and interest. However, if my clients inform me of a penalty, we will explore avenues to get the penalty abated. The point is, however, to report your cryptocurrency transactions in a timely manner. This would include making estimated tax payments on business or investment income involving transactions using cryptocurrency.
Exchange RatesAs mentioned above, transactions using cryptocurrency need to reported in U.S. dollars so you will need to determine that value. It is similar to using exchange rates to determine the value of foreign currencies accepted or used in your business transactions.
Here is a link to an IRS.gov article on exchange rates to help you understand the exchange rate concept.
concept IRS: Foreign Currency and Currency Exchange Rates
The tax treatment of cryptocurrencies is relatively a new area that has complicated aspects to it, as you can see from the information above. I expect to see more clarifications from the federal government over time. If you use or are thinking of using cryptocurrencies I can help you with the tax implications. Just contact me by sending me an email to setup a time for phone conversation.
IRS: IRS reminds taxpayers to report virtual currency transactions
Nasdaq: Understanding Cryptocurrency Tax Obligations
CNN Money: 4 things to know about your cryptocurrency at tax time
Forbes: What You Need To Know About Taxes & Cryptocurrency
CryptoSlate: The Investor's Guide to Cryptocurrency Taxes
The Tax Advisor: Basis issues in crytocurrency
Be careful when reading about tax law and its application, including my articles, because the wording and definitions are such a challenge and are influenced by the writers perspective, specifically his own clients situations that he is mindful of and other situations the writer is not thinking of . The point is talk to your tax professional about your situation and don't draw conclusions based on articles, including from irs.gov, because concepts and definitions are not very clear and, of course, they are subject to change. Now is the time to be having discussions about your situation and developing strategies for you and your businesses. Again, please contact me using my information above to discuss your situation. I help business owners all over the U.S. and foreign countries with their U.S. tax returns.