Cryptocurrency, a type of virtual currency that utilizes cryptography to validate and secure transactions digitally recorded on a distributed ledger (such as a blockchain), has been on the rise over the past several years. Approximately 14 percent of Americans own at least one share of virtual currency. Therefore, it’s essential to understand the tax implications associated with receiving, buying, and selling these currencies, mainly because the IRS is starting to crack down on reporting for capital gains and losses associated with them.
Keep reading to learn more about virtual currency tax reporting and the tax implications associated with cryptocurrency and what the IRS is doing to sharpen its focus on crypto transactions.
What you need to know about virtual currency tax reporting
Much like when you hold investment accounts, cryptocurrency owners must recognize gains and losses when filing their taxes. While gains are typically subject to capital gains taxes, losses can sometimes be used to counteract those gains.
Here are some important details:
- Short-term gains/losses: Virtual currency held for one year or less recognizes gains or losses as short-term gains.
- Long-term gains/losses: Virtual currency held for more than one year recognizes any gains or losses recognized as long-term.
- Calculating: To figure out if you have a gain or loss to report, subtract the value of the cryptocurrency on the day you purchased it (the virtual basis or cost basis) from the value on the day you sold it. If it’s positive, you have gains to report. If it’s negative, you have a loss.
What about using virtual currency as a form of payment?
Whether you’re using virtual currency to pay someone or receiving virtual currency as payment for something, there can be tax implications. When reporting virtual currency received, use the fair market value on the day you received payment. Here are a few popular reasons virtual currency can be exchanged between two parties:
- Payment for goods or services (Payee): If someone uses cryptocurrency to pay you or your business for goods or services, you’ll want to report this as income. If you’re self-employed, this will also be subject to self-employment tax.
- Payment from an employer: If an employer pays you in cryptocurrency, it constitutes wages paid, and you must report it as income received.
- Payment for goods or services (Payer): If you or your business uses virtual currency to pay for goods or services, there will be a gain or loss to recognize for the funds used.
- For more information about the tax implications of using virtual currency, view the IRS FAQ located here.
While it may seem tedious to track every single purchase, exchange, trade, or receipt of virtual currencies, there are online platforms available that analyze the transactions and report to you when you have gains or losses to recognize.
What the IRS is doing with virtual currency tax reporting
The IRS is partnering with TaxBit to help verify cryptocurrency tax calculations during an audit. This tax automation company is automating the cryptocurrency transaction analysis process for the IRS to understand how much money was made or lost from transactions. When the IRS is auditing a tax filing with cryptocurrency, they’ll request the report from TaxBit, who will then provide it to the IRS and the taxpayer.
In addition to these reports, which some taxpayers may see beginning next year, the IRS has also added a question to Form 1040 asking if the taxpayer has sold, exchanged, sent, received, or otherwise acquired any financial interest in virtual currency. With the IRS requiring taxpayers to treat virtual currency as property for Federal income tax purposes, it shows they recognize virtual currencies aren’t going away any time soon.
The Treasury is currently exploring the possibility of requiring reporting on any virtual currency transfers over $10,000. We’re monitoring this and will keep you posted as more information comes to light.
For help with virtual currency tax reporting, reach out to our team of professionals today. Establishing a system to track purchases, sales, and transfers before the end of the year will help ease the burden of preparing for tax season.