The Tax Consequences of Dealing in Cryptocurrency
The coolness factor of digital currency is being closely scrutinized by one of the coolest agencies on the planet: The Internal Revenue Service. Given the speed at which these currencies have caught on — Bitcoin was released only in 2009 — the IRS hasn’t quite kept pace. They issued basic guidelines in 2014 for digital currencies, but tax experts say some of the rules are subject to interpretation.
In 2016 the IRS made it clear that it was searching for cryptocurrency tax evaders: The agency sent a broad request to Coinbase, one of the larger cryptocurrency exchanges in the United States, requesting records for all customers who bought digital currency from the company from 2013 to 2015. Coinbase balked, but a court ruled that it had to provide the records of roughly 14,000 customers, fewer than 1 percent of its patrons, who made transactions involving more than $20,000 of virtual currencies.
So, come April people who have bought and sold cryptocurrency such as Bitcoin will be expected to report any profits on their federal tax returns. And considering digital currency’s wild increases in value in 2017, there are probably many people who incurred gains or losses for the first time. But how much tax you owe will depend on how and when you acquired the digital currency.
Here are some basics about the tax implications of virtual currency:
I sold digital currency last year. What does that do to my tax return?
If you are holding digital currency as an investment, any gains or losses on the sale are treated as capital assets like a stock or bond. The gain or loss is calculated against the market value of the currency when you acquired it (your basis).
If you held the currency for more than a year, you qualify for the less onerous long-term capital gains rates (generally 0, 15 or 20 percent). Short-term gains, from digital coins held for a year or less, are taxed as ordinary income.
As on the stock market, losses can be used to offset capital gains, subject to certain rules, and losses that are not used to offset gains can be deducted — up to $3,000 — from other kinds of income. Unused losses can be carried over to future years.
I’ve successfully ‘mined’ digital currency. Now what?
All cryptocurrency transactions are recorded in a public ledger, which is maintained by a decentralized network of computers. Mining refers to the process by which new digital currency coins are created and then awarded to the computers that are the first to process these transactions coming onto the network. The people whose computers do this most quickly collect a fresh helping of cryptocurrency.
These virtual miners must report the fair market value of the currency (on the day they received it) as gross income and are ultimately required to pay federal, state and most likely self -employment taxes, assuming that the mining constitutes a trade or business.
What are the tax consequences of being paid in digital currency?
Receiving wages from an employer in a virtual currency is like being paid in dollars: it is taxable to the employee, must be reported by the employer on a Form W-2 and is subject to FICA, and federal and state income tax withholding. Independent contractors paid in digital currency must also treat that as gross income and pay self-employment taxes.
What if I paid someone in cryptocurrency for their services?
When you pay an independent contractor in excess of $600 for services performed for your “trade or business,” that should be reported to the IRS and the person receiving the payment for an amount equal to the value of the cryptocurrency when paid.
Can I reduce my tax bill by donating my cryptocoins?
Only people who itemize their tax returns can deduct their charitable donations.
For those who itemize their deductions, it may be possible to directly donate their crytocurrency just as they can directly donate, for example, highly appreciated stock. Just as long as the charity accepts it.
For example, Fidelity Charitable, a donor-advised fund, allows people to give money, take a tax deduction in the same year, and then invest and allocate the money to select charities over time. Fidelity Charitable works with Coinbase, the exchange, to immediately turn the Bitcoin or Ether into cash, which is then invested as its donor wishes.
Will I receive any tax forms such as 1099s from my exchange?
Generally speaking, brokers and exchanges are not yet required to report cryptocurrency transactions to the IRS., as they do when you sell a stock at a profit or loss (and you receive a 1099-B or a 1099-DIV for a mutual fund).
But you will need to keep track of every move you make. Coinbase, for example, refers you to your account transaction history for records to compute your gains and losses; it also provides customers a “cost basis for taxes” report.
How did the new tax bill affect digital currency?
The bill eliminated what some interpreted to be a tax break for virtual currency holders. Under the old rules, some cryptocoin investors applied a legal maneuver often used with real estate investments to defer their capital gains. Under what is called a 1031 exchange, taxpayers can sell one property and defer taxes as long as the proceeds were reinvested in a similar, or “like-kind,” property and met certain requirements.
The IRS didn’t say this strategy could be used with virtual currencies, but some tax experts argued that it was a reasonable — albeit debatable — interpretation since the coins were considered property. Now that the tax legislation limits the use of 1031 exchanges to real estate, this strategy no longer applies. That is if it ever did.