- 1 Cryptocurrency Tax Lawyers
- 2 What does a Cryptocurrency Lawyer do?
- 3 Introduction to Cryptocurrency Tax & the IRS
- 4 Short-Term vs. Long-Term Capital Gains example
- 5 Income Tax & Cryptocurrency
- 6 Tax Rules for Exchanging Cryptocurrency
- 7 You Received Cryptocurrency as a Gift
- 8 You Received Cryptocurrency as an Inheritance (Step-up)
- 9 1031 and Cryptocurrency
- 10 Inventory
- 11 Avoiding Tax
- 12 Reporting Foreign Bitcoin/Cryptocurrency
- 13 Are you out of Compliance?
- 14 Golding & Golding: About Our Tax Law Firm
Cryptocurrency Tax Lawyers
Cryptocurrency Tax lawyers: Cryptocurrency Tax Law is still evolving. When it comes to compliance, Taxpayers may have one or several cryptocurrency tax issues to contend with. Sometimes, it is because the Taxpayer has not properly reported their cryptocurrency transactions, income, capital gains, and dividends to the IRS, and they want to get into tax compliance. Other times, it is because the Taxpayer has already received (or is worried about receiving) an IRS Letter 6173, 6174, or 6174-A and is unsure how to proceed.
Over the past few years, crypotcurrency has steadily progressed into one of IRS’s key enforcement priorities.
In fact, even the new (draft) 1040 form includes a preliminary question about the purchase, sale or transfer of virtual currency, on the first page of the form.
And, with the IRS taking an aggressive position on matters involving U.S. and international cryptocurrency matters, it is important for Taxpayers to be in tax compliance.
What does a Cryptocurrency Lawyer do?
When it comes to Cryptocurrency, some of the key issues involve:
- Cryptocurrency Income Tax
- Cryptocurrency Capital Gain Tax
- Cryptocurrency Investment and PFIC Reporting
- Reporting Cryptocurrency on an FBAR
- Disclosing Offshore Cryptocurrency on International Informational Returns
Introduction to Cryptocurrency Tax & the IRS
Let’s go through some of the basics involving cryptocurrency tax law:
Do I Pay Tax When I Purchase Cryptocurrency?
Cryptocurrency is considered property.
When a person purchases property they do not pay tax on the purchase, because the mere purchase of property is not a taxable event.
For example, last week you purchased a home for $900,000.
You are not taxed on the purchase of the home, because it is not a taxable event.
The Purchase Date and Value of Cryptocurrency is Important
The date you purchased cryptocurrency (and fees you paid), will typically form the basis of your “property” and is a very important value.
This is called your “basis.”
That is because at a later date, when you sell or exchange the cryptocurrency, the basis will serve as the purchase/acquisition price — and will help determine what taxes you a may owe to the IRS.
What Happens When You Sell Cryptocurrency?
When you sell cryptocurrency, you have engaged in a taxable event.
At the most basic level, you purchased something previously, and now you want to sell the property — hopefully for profit — which is considered Capital Gain (excluding inventory).
Example of a Cryptocurrency Sale and Tax
David purchased $25,000 of Bitcoin on January 1, 2019, and sold it on December 15, 2019 for $30,000.
When David sold the Bitcoin for $30,000, he made $5000 — and the IRS wants to tax David on his $5,000 profit.
Short-Term Capital Gain
Since David purchased and sold Bitcoin in the same year, he held the cryptocurrency for less than a 12-months and it is considered a short-term capital gain.
A short-term capital gain is taxed at the Taxpayer’s progressive (net-effective) tax rate.
In other words, there is no special tax credit or treatment for short-term sales of a property (exclusions, exemptions, and limitations permitting)
Long-Term Capital Gain
Referring to the same example from above, instead of selling the Bitcoin on December 15, 2019, he sold it on February 8, 2020.
This changes the nature of the cryptocurrency sale. That is because more than 12-months has passed since David purchased the Bitcoin.
Therefore, David’s sale will be considered a long-term capital gain.
The reason why this is important, is because long-term capital gain receives beneficial tax treatment.
Long-term capital gains has a preferred tax rate.
The tax rate for long-term capital gains is 15% unless a person falls into the top tax bracket, in which the tax rate jumps to 20%.
**Long-term capital gains rules change constantly, so it’s important to keep up with the rules in the year you sold it.
Short-Term vs. Long-Term Capital Gains example
Michelle and David each earn $800,000 a year and are both in the top tax bracket.
If David and Michelle each purchased cryptocurrency for $30,000 and each sold it for $100,000, here is how the different situations tax situations will play out:
David’s Short Term Gain
David would have a $70,000 dollars again that will be taxed as ordinary income tax rate, and his net effective tax rate would be around 35% (about $25,000).
Michelle’s Long Term Gain
Michelle has a $70,000 that will be taxed at 20%.($14,000).
If Michelle was not in the top tax bracket, it would only be taxed at 15% ($10,500).
Income Tax & Cryptocurrency
If a person receives cryptocurrency in lieu of wages for work performed, then the cryptocurrency value is determined on the day it is received and Income taxes must be paid.
In other words, if your employer paid you $400,000, but paid you in cryptocurrency instead of a check or cash, you still owe income tax that you would have otherwise had to pay if you had receive the money via regular currency – and you would have to pay any potential social security tax, NIIT, etc.
The idea is this: The IRS is not going to let you or your employer circumvent the tax rules to avoid paying tax, just because you received cash equivalent instead of actual cash.
From a baseline perspective — you work, and as a result of your work you were paid, and now the IRS wants its cut.
Your basis in the future sale of the cryptocurrency at a future time would be $400,000.
Tax Rules for Exchanging Cryptocurrency
Exchanges in general can be confusing when it comes to the taxation portion of the exchange.
Here is a typical example:
- Jennifer purchased Bitcoin for $10,000 and is now worth $20,000.
- Peter purchased Litecoin for $5,000 and is now worth $17,000.
For one reason or another Jennifer wants to Exchange her bitcoin for Peters Litecoin.
Jennifer: Jennifer has a basis $10,000. She is receiving Peter’s cryptocurrency for $17,000, which is the current market value. Jennifer has a gain of $7,000 of which she will pay tax on.
In the future, when Jennifer wants to sell her cryptocurrency, her new basis would be $17,000 instead of $10,000 because she paid tax on the full value.
Peter: Peter has a basis of $5,000 in the Litecoin. He is receiving cryptocurrency worth $20,000. Therefore, Peter has a gain of $15,000, which he will also pay tax on.
In the future, if he wants to sell cryptocurrency, his new basis will be $20,000.
In other words, when you exchange one piece of property for another, you receive the property at the current market value.
So, if you received a piece of property which is more valuable than the property you have, you pay capital gain tax (usually) on the gain.
You determine the tax by subtracting the cost of the purchase of the property from the market value of the property you received, to determine your gain amount – and you pay tax on the gain amount.
You Received Cryptocurrency as a Gift
If you receive cryptocurrency as a gift, the typical tax rule is that you receive the carryover basis, which will serve as the basis for your crypto currency.
For example, your grandma purchased cryptocurrency a few years back for $20,000. Since your grandma spends her days researching cryptocurrency, she believes her investment is going to increase in value.
Your grandma was correct, because now it’s worth $400,000.
She gives you the cryptocurrency and tells you to go enjoy yourself.
You decide you want to buy a house, but they do not accept Cryptocurrency as legal tender, so you sell the crypto first.
Do you receive $400,000 tax-free, since that is the Fair Market Value on the date you received it?
No. Rather, when you receive the gift from your grandma, you have to take it at that value she purchased it for, which is $20,000 – which also means you have a $380,000 gain on the exchange. (aka Carry-Over Basis)
You Received Cryptocurrency as an Inheritance (Step-up)
Unfortunately, your sweet grandma passed away before she had a chance to give you the gift.
But, she was smart, she had a will, and she left you her cryptocurrency in the will.
Under estate tax rules, you receive the market value of the property on the date your grandma passed.
Therefore, the value of the cryptocurrency you receive is now $400,000, so when you sell the Crypto for $400,000, you do not pay any tax.
1031 and Cryptocurrency
A 1031 exchange is a way to defer tax. ‘
For example, you have a rental property that you purchased for $100,000 that is now worth $1,000,000.
You don’t want to sell the property and pay tax, so you would rather shift the investment into a new rental property or something similar (since you are relocating)
You execute a 1031 exchange (which has very specific timing rules and holding requirements) and absent any boot (usually cash or mortgage payoff in addition to the property) you receive a new property, while maintaining the same basis ($100,000) and it is not considered a sale, so that you do not have to pay Capital gains tax at the time.
Unfortunately, at this time1031 rules do not apply to cryptocurrency for exchanges for coins in 2018 and subsequent (e.g., when filing your 2017 tax return in 2018 regarding prior exchanges, there may be room for debate, but most likely not for exchanges made in 2018 going forward)
Selling Cryptocurrency as inventory is complex and beyond the scope of this article (LIFO, FIFO, COGS, etc.)
If you knowingly traded or sold cryptocurrency, and intentionally avoided paying tax, or reporting the sales or exchanges on a Schedule D/Form 8949, you may find yourself in hot water.
Most, if not all cryptocurrency exchanges track and report the information, and will provide it to the IRS – whether they want to or not.
Coinbase is one of the largest (if not the largest) crypto exchange.
Coinbase lost their fight against the IRS, and has to disclose the names of many of their clients.
Since cryptocurrency has been dubbed “the new Swiss bank account,” and the IRS refuses to knowledge cryptocurrency as currency, there is a high likelihood that the IRS will take a heavy hand against anybody believe isn’t only evading tax and reporting.
Reporting Foreign Bitcoin/Cryptocurrency
This is where it can get infinitely more complicated, primarily because of the lack of direction by the U.S. Government, coupled by the penalties associated with noncompliance of required foreign disclosure activities.
At the current time, FinCEN and the IRS are not clear as to overseas cryptocurrency reporting.
Goal of Foreign Reporting is to Promote Financial Transparency
From the IRS and FinCEN’s perspective, the purpose of filing the FBAR and other related international informational returns is to promote transparency.
Typically, the Government and courts will err on the side of the U.S. government as opposed to splitting hairs and throwing support behind nuances argued by Taxpayers seeking to avoid reporting and/or maintain anonymity.
Presumably, if you were ‘holding’ the cryptocurrency in your own personal wallet on your own personal computer, chances are it would not be reported.
But, the further away you drift from that situation, the more you have to consider whether you should report.
- Is there both virtual currency and regular currency in the same account?
- Have you exchanged the currency for cash and left it in the trading account?
- How much cryptocurrency do you actually have in the foreign Account?
Are you out of Compliance?
It is human nature to want to avoid making a proactive submission to a government agency such as the IRS before the IRS ever discovers the non-compliance — but, typically that is best path forward.
Golding & Golding: About Our Tax Law Firm
Golding & Golding specializes exclusively in IRS Voluntary Disclosure & U.S./Offshore Compliance.
Contact our firm today for assistance.