There’s no doubt about it: cryptocurrencies continue to make waves.
In a landmark moment for the digital asset industry, Bitcoin’s first exchange-traded fund (ETF) recently hit the New York Stock Exchange. A record-high followed by a precipitous tumble has kept the virtual currency in the news lately, and meanwhile, even Walmart has begun offering Bitcoin through some ATMs.
Whether you are already invested in a cryptocurrency such as Bitcoin, Ethereum, or Dogecoin, or you are considering investing in or using a digital currency, you must keep up-to-date on the changing tax implications.
I have previously discussed cryptocurrency on this blog. For example, in this post, I discussed what cryptocurrency is, how to keep track of your currencies for tax purposes, and why virtual currencies are a risky investment.
With Congress now considering legislative changes to the tax rules related to digital assets, this is an excellent time to revisit the topic.
The Treasury Department is already ramping up efforts to crack down on cryptocurrency tax noncompliance. A bill currently under debate in the House of Representatives could include new reporting requirements.
What does this mean for you? Read on to learn more about how the IRS currently treats cryptocurrency, the changes that are being proposed, and what implications those changes could have for your taxes.
Let’s start with the obvious: You must report any cryptocurrency transactions.
Just because the U.S. government does not back cryptocurrencies, that does not mean the IRS and subject do not regulate them to taxation. In fact, as of the 2019 tax year, every federal taxpayer must now state on their 1040 form whether they have received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency.
However, an update to the original guidance on that new question has confused taxpayers and tax professionals alike. To make matters worse, understanding exactly how to report your crypto transactions is not always easy.
In guidance issued initially in 2014 and expanded upon in 2019, the IRS intended to treat virtual currency as property, not as currency, for federal tax purposes. As of the time of this writing, that guidance still applies.
(Readers should note that new guidance or regulations could happen subsequent to this writing, and I may not immediately update this post. Reach out to us to get the latest.)
Because the IRS considers any cryptocurrency held as a capital asset to be property, tax principles that apply to a property will generally apply to cryptocurrency transactions, too. That means any gain or loss from the sale or exchange or your virtual currency will be subject to capital gains tax rates.
If you possessed your cryptocurrency for a year or less before selling or exchanging it, the digital asset is taxable as short-term gains; the federal tax rate for this is the same as the rate for income and can range from 10% to 37%, depending on your taxable income bracket.
On the other hand, let’s say you held onto your currency for over a year. In that case, your profits from selling or exchanging it are taxable as a long-term capital gain, and the tax rate will usually range from 0% to 20%, depending on your income.
Selling cryptocurrency for “fiat” currency (government-issued currency not backed by a commodity such as gold), using it to buy goods or services, or trading one crypto asset for another are all capital gain tax events.
The IRS considers other types of taxable events, however, as income tax events. These events are generally taxed according to your personal income tax bracket and can include:
One more thing is important to know: For tax purposes, you must report transactions using virtual currency in U.S. dollars. You will need to determine the Fair Market Value (FMV) of your currency as of the date of the transaction.
Fair Market Value is the amount of money an asset would sell for on the open market. When it comes to virtual currencies, the sale price is usually converted to U.S. dollars according to the exchange rate.
The bipartisan infrastructure bill currently under consideration in the House of Representatives includes a provision introducing new reporting requirements related to cryptocurrency transactions.
Intended as an offset to help fund the infrastructure bill, this new provision would create an estimated $28 million in revenue by increasing tax compliance among cryptocurrency traders.
Under current law, crypto exchanges and others involved in facilitating digital currency transactions are exempt from certain reporting requirements. For example, they are not required to report their customers’ losses and gains, as a traditional broker would be. As a result, the IRS often does not know about a given taxpayer’s income from cryptocurrency, and gains are often significantly under-reported.
The proposed new rule would expand the definition of the word “broker” to include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”
The result? Digital asset traders would be required to report the names, addresses, and gross proceeds associated with their transactions.
Crypto advocates have objected to this provision, claiming the language is too broad. They have suggested revising the language to exclude virtual currency miners and software developers, who do not usually have customers. They, therefore, typically do not have access to the information needed to comply.
The debate over these points is ongoing, and we must wait and see what form any new regulations on the cryptocurrency industry may take once passed into law. But one thing seems clear: Sooner or later, the IRS will crack down on unpaid cryptocurrency taxes.
While crypto tax cheats may have the most to fear if the proposed changes become law, even those who aren’t aware of any unpaid taxes may experience the impact. After all, as I mentioned earlier, the IRS doesn’t necessarily make it easy to report your virtual currency transactions accurately.
As previously discussed, Form 1040 now includes a question asking the taxpayer whether they purchased or acquired virtual currency during the tax year. Yet, the updated guidance issued this year states that if your only transactions “were purchases of virtual currency with real currency, you are not required to answer yes to the Form 1040 question.”
Far from yielding clarity, this guidance left even tax practitioners scratching their heads. Taken along with how limited the existing IRS guidance on the topic is and how many questions remain unanswered, you understand that reporting errors may happen.
What does that mean? Although you may not have intended to hide taxable crypto income from the government, you may have inadvertently under-reported.
In the event of new regulations, such as those under debate, becoming law, they will likely require exchanges to issue 1099-B forms detailing gains and losses to their customers. If so, the burden in terms of calculation may not fall too heavily on the taxpayer.
It’s possible, of course, that the current proposals will not end up as law. Nevertheless, if you expect to earn gains on cryptocurrency in the years to come, you should also expect to pay more taxes on those gains.
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
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Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
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He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
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In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
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