- 1 Cryptocurrency and Bitcoin Tax Lawyers Worldwide
- 2 What do Cryptocurrency Tax Lawyers do?
- 3 An Introduction by our Cryptocurrency Tax Lawyers
- 4 Income Tax & Cryptocurrency
- 5 Tax Rules for Exchanging Cryptocurrency
- 6 You Received Cryptocurrency as a Gift
- 7 You Received Cryptocurrency as an Inheritance (Step-up)
- 8 1031 and Cryptocurrency
- 9 Inventory
- 10 Avoiding Tax
- 11 Reporting Foreign Bitcoin/Cryptocurrency
- 12 FBAR /FinCEN 114
- 13 Do You Report Overseas Cryptocurrency?
- 14 FBAR Rules are Contradictory
- 15 Remember the Purpose of Foreign Reporting
- 16 Are you out of Compliance?
- 17 Golding & Golding: About Our Tax Law Firm
Cryptocurrency and Bitcoin Tax Lawyers Worldwide
The past few years have been a whirlwind for investors in cryptocurrency. While values have skyrocketed, the Internal Revenue Service and US Government in general have placed cryptocurrency at the top of the compliance enforcement list. Whether it was the introduction of the J-5 Global Initiative; issuance of Letters 6173 and 6174; the introduction of FinCEN regulations — or the passage of the infrastructure bill — cryptocurrency is at the forefront of enforcement. In fact, the Justice Department recently stated that it anticipates seizing billions in fraudulent crypto. The Tax rules for cryptocurrency are also in flux. In general, Taxpayers will pay tax on the sale or exchange of cryptocurrency such as Bitcoin and Ethereum — the mere purchase of crypto and other virtual currency is not a taxable event. Our Board-Certified International Tax Law Specialist team and cryptocurrency tax lawyers have summarized the basics of cryptocurrency — although it is important to keep in mind that the rules are in flux.
What do Cryptocurrency Tax Lawyers do?
Different types of cryptocurrency tax lawyers handle different types of issues. For example, at Golding & Golding, we specialize in Voluntary Disclosure and Offshore Tax Amnesty. When it comes to Cryptocurrency, some of the key issues involve:
Cryptocurrency Income Tax
Cryptocurrency Capital Gain Tax
Reporting Cryptocurrency on an FBAR
Disclosing Offshore Cryptocurrency on International Informational Returns
Cryptocurrency PFIC Reporting
An Introduction by our Cryptocurrency Tax Lawyers
The foundation for the rules and regulations involving cryptocurrency are still being laid, but the following is a summary of the basics involving how cryptocurrency should be taxed and may be recorded.
Here are some of the basics:
Do I Pay Tax When I Purchase Cryptocurrency?
Cryptocurrency is considered property.
When a person purchases property, they do not pay tax because the purchase price of property is not a taxable event.
For example, last week you purchased a home for $300,000.
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.
Here’s how it works:
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 same tax rate as regular income.
Therefore, 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, 2017, he sold it on February 8, 2018. 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 somewhere between 35 to 40%. (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 as a result of employment, 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, so we are going to do our best to keep it very simple, using this 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
This is a common issue our cryptocurrency tax lawyers see daily: 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 aka (Stepped-Up Basis).
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 time 1031 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.)
Another common issue cryptocurrency tax lawyers have to handle is related to tax compliance. If a person knowingly traded or sold cryptocurrency, and intentionally avoid 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 crypto-exchanges track and report the information, and will provide it to the IRS – whether they want to or not.
In fact, even Coinbase one of the largest (if not the largest) exchange lost its fight against the IRS, and has to disclose the names of many of it 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.
Here are the basics:
FBAR /FinCEN 114
FBAR (Report of Foreign Bank and Financial Account form) was created by FinCEN, is now enforced by the IRS.
If a person has more than $10,000 on any day of the year in foreign accounts (not limited to bank accounts), then the person is required to disclose this information annually on an FBAR.
The failure to properly report may result in penalties stemming from a warning letter, all the way up to a 100% penalty in a multiyear audit.
Do You Report Overseas Cryptocurrency?
FinCEN and the IRS are not clear as to overseas cryptocurrency reporting.
Since the IRS has determined that cryptocurrency is actually property and not currency, common sense would dictate that it would not need to be reported on the FBAR…since the FBAR it Is used to report foreign accounts.
But not so fast….
FBAR Rules are Contradictory
The FBAR rules can be confusing.
For example, a safety deposit box in the bank would not be considered an account, and if you read various blogs they would all say that a safety deposit box is not considered an account.
The blog will also tell you the precious metals and stones of course do not need to be reported.
But, if you refer to the Internal Revenue Manual you will find the following clarification:
“Safety Deposit Box
A reportable account may exist where the financial institution providing the safety deposit box has access to the contents and can dispose of the contents upon instruction from, or prearrangement with, the person.
Precious Metals, Precious Stones, or Jewels Held Directly by the Person
31 USC 5314 defines “foreign financial agency” as “a person acting for a person as a financial institution, bailee, depository trustee, or agent, or acting in a similar way related to money, credit, securities, gold, or a transaction in money, credit, securities, or gold.”
Therefore, a reportable account relationship may existwhere a foreign agency holds precious metals on deposit or provides insurance or other services as an agent of the person owning the precious metals.
In other words, the information can be conflicting. This is primarily because even though the FBAR is being enforced by the IRS (and they have their own internal Revenue manual), the form was created by FinCEN, which has its own enforcement standards.”
In other words, be careful reading blogs by self-purported tax experts.
Remember the Purpose of Foreign Reporting
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 people 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 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
It is important to know that in recent months enforcement of Bitcoin/Cryptocurrency has been stepped up.
Specifically, with the courts approving a slimmed-down version of the IRS subpoena against Coinbase, your information is nowhere near as private or anonymous these companies would like you to believe it is.
** In addition to FBAR, you may also have other reporting requirements under FATCA, Form 3520, Form 3520-A and Form 8621 (amongst others).
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 international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance with getting compliant.