Cryptocurrency and U.S. Income Taxes

Cryptocurrency and U.S. Income Taxes

The 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 Consequences

The 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.

Conversion

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. 

Tracking Value

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.

Exchanging Cryptocurrency

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 Gain

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.

Foreign Transactions

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 report

Receipt 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 Accounts

For 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 Interest

Keep 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 Rates

As 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.

Jeff Haywood, CPA
The CPA Superhero
jeff.jhtaxes@gmail.com
217-923-8007

References:

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.

Qualfied Business Income Deduction




Some business owners will get a deduction based on business income from for 2018 under the new Tax Cuts and Jobs Act (TCJA). Do you qualify? For Business Owners, I will help you get a general idea about the 20% Qualified Business Income Deduction. Keep in mind several of the words and concepts mentioned have not been clearly defined, so tax experts are seeking clarifications on many of the issues and definitions of various terms used. 

Qualified Business Income Deduction

It appears the intent with the 20% Qualified Business Income Deduction is to level the playing field for all business types. It seems that other business types were given this deduction due to the reduction in Income Tax Rates given to C Corporations. I will address some of the business types that could benefit from this deduction, including sole proprietors, partnerships, and S Corporations. The deduction is to give the owners, partners, and shareholders of these entity types a deduction on their personal tax returns.

Basic Deduction

Basically the deduction is the lesser of the following:

   a) 20% of your pass through "Qualified Business Income" (QBI) plus 20% of your qualified REIT dividends and qualified PTP income or

   b) 20% of your taxable income minus your net capital gains

What if you are limited by b) 20% of your taxable income minus your net capital gains, can you carry forward the portion you are not allowed to take this year? No, if you can't take all of your 20% of your pass through "Qualified Business Income" then you lose it.

However, there are qualifications and limitations to take into account.

Qualified Business Income

First, what is "Qualified Business Income" (QBI)? QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. This income must be connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded. QBI also does not include reasonable salaries paid to shareholders of an S Corporation or Guaranteed Payments to partners for services rendered to a business not dependent on the partnership's income level. 

Qualified Trade or Business

What businesses are not qualified? The IRS mentions, other than C Corporations, two types of businesses, Specified service trade or business (SSTB), and performing services as an employee.

However, income from a SSTB does not qualify only if the taxpayer has taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,000 for all other taxpayers. So for purposes of this article I am going to present this type of business as one that can qualify but with that limitation. It's just semantics. 😕😕😕

Domestic Business Qualification Question???

It is important to note that the deduction only applies to qualified income from a Qualified Trade or Business that is a domestic business. Here is how it is stated on IRS.gov:
Eligible taxpayers may be entitled to a deduction of up to 20 percent of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. 
Notice the reference to "a domestic business". What is that? I don't think that is clear yet. However, the IRS also indicates the following in regard to Qualified Business Income:
QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.
Notice the reference to "income effectively connected with a U.S. trade or business". This expression is used in the tax law to require foreign businesses in anyway doing business in the U.S. to report income on a U.S. tax return.

So look for clarification of this issue. Absent such clarification it should be important to carefully develop strategy and keep good documentation. I would also be ready to comply by tracking revenue according to these categories. This would involve some discussions about the specific situation for the business in question. 😀

Overall Limitation

The QBI deduction is limited to 20% if the taxpayer's taxable income in excess of any net capital gain. Again, there is no carryover of the used portion because of this limitation.

Other Limitations

Qualified Wage and Capital Limitations


The QBI deduction may also be limited by a qualified wage and capital limitation and/or a limitation for s SSTB. These limitations are calculated based on the taxpayer's taxable income. The taxable income thresholds for 2018 are outlined below:

Taxable Income MFJ/Single or other
Below $315,000/$157,500                                                           No Limit
Between $315,000-$415,000/$157,500-$207,500                      Partial Limitation
Above $415,000/$207,500                                                          Fully Applied Limitations

Taxpayers above the $415,000/$207,500 threshold are subject to another limit:
The lesser of:

  • 20% of QBI or 
  • The greater of 50% of the taxpayer's share of qualified W-2 wages for the business, or 25% of the qualified W-2 wages plus 2.5% of the business's unadjusted basis in all qualified property.
Taxpayers in the middle threshold are subject to a prorated portion of the limitations mentioned above. The prorated percentage is the amount of taxable income in excess of the threshold divided by $100,000/$50,000. This ratio is multiplied by the difference between the pre-limitation deductible QBI amount and the fully phased-in wage and capital limitation amount. This is the amount used to reduce the pre-limitation deductible QBI amount.

Just contact me for help.

Limitation for Specified service trade or business (SSTB)

There are limitations for what are called specified service trade or business (SSTB), which are trades or businesses involved in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. There is no limitation for QBI from an SSTB for taxpayers whose taxable income is less than $315,000 for a married couple filing a joint return, or $157,000 for all other taxpayers. However, there the deduction is limited for taxpayers whose income is between $315,000 and $415,000 for MFJ filers and $157,500 and $207,500 for all other taxpayers. The limitation is the same as the discussed for Qualified Wage and Capital Limitations. However, for taxpayers over the top threshold there is no deduction allowed for QBI from an SSTB.

More to Come

This post addresses just the basics of the Section 199A - Qualified Business Income Deduction. I have in mind additional posts about other specifics later. 

The Situation Now

This is a unique time with complicated aspects of the new tax law, the Tax Cuts and Jobs Act. There is much discussion among tax preparers about the definitions and issues and we will see that increase as we start preparing returns for 2018. I have been going through scenarios and having ongoing discussions with my business clients about their specific situations and we are working on strategies for this year and on into the future. I can help you too with your situations. Just contact me  by sending me a text or an email to setup a time for an initial phone conversation.

Jeff Haywood, CPA
The CPA Superhero
jeff.jhtaxes@gmail.com







The above information is general information, it is not all inclusive, and keep in mind, in your tax situation everything "depends on facts and circumstances." So call me to talk about your specific facts and circumstances.


References






Be careful when reading articles about your finances or the tax law and its application, including my articles, because the wording and definitions are such a challenge and the articles 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 CPA 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 and strategies to reach their goals.

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