Taxes on Cryptocurrencies, Virtual Currency, BitCoins
Cryptocurrencies or Virtual Currencies are not common to some businesses. However, in case you are a business that deals with virtual currency, you want to pay attention to this article. We will discuss: Valuation, transactions, Character of Gain or Loss, Foreign Currency Transactions, Foreign Bank and Financial Account (FBAR) Reporting, Payment for Goods & Services, Acquiring Virtual Currency, Virtual Currency Mining, Employee Payments, and Independent Contractor Payments. All of which are critical to understand, especially for tax purposes.
Virtual Currency
As our world has become more and more “digital,” it was only a matter of time before cryptocurrencies hit the market. One of the first of these virtual currencies was Bitcoin, and the Bitcoin network came online in 2009. Since then, there has been the development of more cryptocurrencies.
Usually, tech-savvy individuals use Cryptocurrencies for transactions. These have a comparable value in real currency or take the place of real currency. These virtual currencies are bought with U.S. dollars, euros, and other real or virtual currencies. The exchange of cryptocurrencies is the same.
Valuation
The value of a virtual currency is based upon market value — what a willing buyer will pay a willing seller. This is much like trading in stocks. According to Oanda (an online currency converter), a Bitcoin, one of the more popular virtual currencies, was worth $9,025. One year ago, it was worth $995 one year earlier.
Transactions
It took several years for the IRS to come up with guidance on how to deal transactions involving virtual currencies. Finally, a Notice 2014-21 came out determining that virtual currency has the same treatment as property. And, that the general tax principles applicable to property transactions apply to transactions using virtual currency. Here are two examples below:
Character of the Gain or Loss
The character of the gain or loss depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer realizes capital gain or loss on the sale or exchange of virtual currency, that is a capital asset. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that he or she does not hold as a capital asset. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset.
Foreign Currency Transactions
Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
Foreign Bank and Financial Account (FBAR) Reporting
The IRS has stated a few years ago that virtual currency transactions need not be reported for purposes of Foreign Bank and Financial Account (FBAR) reporting. But the IRS cautioned that its position could change in the future. However, the IRS has not issued any announcements regarding a change in its position on FBAR filings for years through 2017.
Payment for Goods & Services
A taxpayer subject to U.S. taxation who receives virtual currency as payment for goods or services must, in computing gross business income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.
Acquiring Virtual Currency
One can go to online exchanges and purchase virtual currency. Make sure the exchange is reputable. Once you have the virtual currency in your online wallet, you are free to spend it with anyone who accepts it.
Virtual Currency Mining
Mining is a term that describes how cryptographic information distributed within a virtual currency network is secured, authorized, and approved. In essence, it is the processing of payments that have taken place once they occur. It takes the place of banks, merchants’ accounts, and clearing houses like Visa. Essentially, it eliminates all of the third parties’ cuts of income from the transaction. It involves complex mathematical logarithms. The mining process completes this task autonomously. For individuals who mine virtual currency, it is a trade or business, and they are subject to self-employment tax.
Apparently, virtual currency miners are also subject to Form 1099-K filing requirements if their transactions rise to the reporting threshold. In general third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third-party settlement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third-Party Network Transactions. If, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200 and (2) the gross amount of payments made to the merchant exceeds $20,000, then 1099-K filing is required.
Employee Payments
Let’s say an employee is paid in virtual currency. The fair market value of the virtual currency, in U.S. dollars, paid as wages, is subject to federal income tax withholding. It is subject to Federal Insurance Contributions Act (FICA) tax (Social Security and Medicare A), and Federal Unemployment Tax Act (FUTA) tax. Therefore the employer must issue a Form W-2, Wage and Tax Statement. The U.S. government doesn’t accept virtual currency for tax payments.
Independent Contractor Payments
The fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income to the independent contractor and is subject to the self-employment tax. Payments are subject to the normal 1099-MISC reporting requirement when the payments for the year measured in U.S. dollars are $600 or more.
IRS Enforcement Actions
Because fewer than 900 taxpayers reported virtual currency gains and losses each year on their tax returns from 2013 to 2015, the IRS is stepping up enforcement of the rules. Recently, the IRS won a court’s approval for a summons to obtain account and transaction information on more than 14,000 customers from Coinbase, a company that services buyers and sellers of Bitcoins. Based on the success in the Coinbase case, the IRS will likely expand its efforts to obtain information about cryptocurrency account owners from other companies dealing in Bitcoins and similar virtual currencies.
Also, beginning with 2018 returns, Sec. 1031 tax-deferred exchanges will only apply to real property. Thus, investors in virtual currency who trade one type of virtual currency for another will be have to report their capital gains/losses and won’t be able to use the 1031 tax-deferral rules.
Do you use Cryptocurrencies or Virtual Currency?
Do you invest, trade, or deal in virtual currency (also known as cryptocurrencies)? Perhpas you have questions about how those activities will affect your tax situation? Give our tax specialist Alex Franch, a call at 781.849.7200 or email us at contactus@worthtax.com. You can also book an appointment online here.
We would love to hear your comments below about your experience with Cryptocurrencies. Do you think you will make money or lose it in the future and why?
Alex Franch, BS EA
Alex is a Tax Specialist and Partner at Joseph Cahill & Associates / WorthTax. He has a diverse background including a Bachelor of Science from Boston College in Mathematics and extensive military service. Alex is an Enrolled Agent and has a decade of tax preparation experience. He is passionate about serving businesses with tax and financial planning strategies.
Mr. Franch is licensed by the Financial Industry Regulatory Authority (FINRA). He holds a Series 6, 63, 65, and 7, and by the Commonwealth of Massachusetts Division of Insurance.
Alex Franch is a registered representative of, and offers securities and investment advisory services through, Commonwealth Financial Network. He is a registered broker-dealer, Member FINRA/SIPC.
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