Cryptocurrency Tax Guide – How Does IRS Tax Cryptocurrency?
Cryptocurrency Tax Guide: When it comes to Cryptocurrency, the IRS, and Tax laws — the rules, exceptions, and exclusions are enough to make your head spin.
- 1 Cryptocurrency Tax Guide
- 2 Is Bitcoin/Cryptocurrency Taxable?
- 3 A Friendly Reminder that What Goes Up…
- 4 Cryptocurrency Income Tax
- 5 Cryptocurrency Capital Gain Tax
- 6 Exchanging Cryptocurrency such as Bitcoin
- 7 Reporting Foreign Bitcoin/Cryptocurrency
- 8 FBAR /FinCEN 114
- 9 Do You have to report foreign held cryptocurrency?
- 10 FBAR Rules are Contradictory
- 11 Remember the Purpose of Foreign Reporting
- 12 Are you out of Compliance?
- 13 Golding & Golding, A PLC
Cryptocurrency Tax Guide
The taxation of IRS Bitcoin and IRS Cryptocurrency has not been fully solidified.
There is mass confusion in the marketplace – primarily due to the fact that there are many stones left unturned by the IRS, FinCEN, and foreign tax jurisdictions etc. when it comes to deciphering cryptocurrency.
Common Cryptocurrency/Bitcoin questions include:
- Is Bitcoin/Cryptocurrency Taxable?
- What are Bitcoin.Cryptocurrency Taxes?
- What is Bitcoin/CryptocurrencyIncome Tax?
- What is Bitcoin/Cryptocurrency Capital Gains Tax?
- How do taxes work?
- What is Cryptocurrency…Currency?
- Is Cryptocurrency…Property?
- How is Cryptocurrency taxed?
- Are Foreign Crypto Accounts/Wallets FBAR/FATCA reportable?
Is Bitcoin/Cryptocurrency Taxable?
*Since so many people use Bitcoin interchangeably with cryptocurrency, we will refer to them together within this article.
Each one of these distinctions is very important, because it helps to assess whether a person is liable for U.S. tax or not, and/or whether the person is in compliance with IRS and FinCEN foreign account and asset reporting rules — especially because the failure to be in compliance may result in significant fines and penalties.
The following is a breakdown summary of the basics:
While Cryptocurrency is generally referred to as currency, it actually depends on who you ask.
IRS & Bitcoin/Cryptocurrency
For example, in accordance with the IRS, cryptocurrency is not considered currency at all. Rather it is considered property – and that will have a major impact when it comes to taxation (see below)
FinCEN & Bitcoin/Cryptocurrency
Likewise, under FinCEN, cryptocurrency is defined as something that has some of the attributes of Currency, but not all of the attributes of real currency. This is even more confusing, since for example the FBAR (FinCEN 114) is actually enforced by the IRS.
Foreign Country & Bitcoin/Cryptocurrency
Outside of the United States, the rules are also different. Some countries do not tax cryptocurrency, some countries tax cryptocurrency at a reduced tax rate — and even the definition of cryptocurrency is different and varies from country-to-country. For example the European banking authority describes cryptocurrency as a “digital representation of value…. accepted by natural legal persons as a means of payment.”
The takeaway from all this? Is that while it is unclear what the specific definition update Bitcoin/Cryptocurrency is, under U.S. law there is a strong indication that per IRS Rules, cryptocurrency is not technically currency and should not be thought of as currency when exchanging, purchasing or selling it.
A Friendly Reminder that What Goes Up…
…Usually comes down.
It is important to note, that while currently (aside from a recent hiccup) the value of cryptocurrency continues to rise — this is not always the case. Throughout its inception (since 2009), cryptocurrency has seen many ups and downs, including a complete crash in 2013, as well as various instances of hacking, theft, and other unwanted intrusions.
It is important to track your particular cryptocurrency, because depending on whether or not there is a breach of your wallet would not necessarily negate any tax liability you may have for the exchange or sale of Bitcoin in that same year.
Cryptocurrency Income Tax
If a person exchanges services and receives cryptocurrency in exchange for their services, the recipient has received income, and that income must be reported on a tax return, and taxed.
For example, David works as a consultant for a company and receives a 1099-Misc and $20,000 worth of Bitcoin Cash. David will book $20,000 dollars as income.
Cryptocurrency Capital Gain Tax
When a person sells Bitcoin or other crypto, it is the equivalent selling property. For example, if David purchased a house for $100,000 and sold a house five years later $150,000 (non-primary residence), then David would have a capital gain on the difference between the basis and the sale price – the same holds true for cryptocurrency.
For example, David purchased $50,000 dollars of cryptocurrency, and then sold it two years later for $75,000, David would have capital gain tax on the sale, which he would presumably report on schedule D with an accompanying form 8949 to detail each transaction.
Exchanging Cryptocurrency such as Bitcoin
This is a bit more complicated but mimics the concept of the sale of Bitcoin. For example, David purchased Bitcoin for $10,000 which is now worth $15,000.
David exchanges his Bitcoin with Michelle’s other cryptocurrency, because David believes it is gaining traction in the market. Michelle purchased her cryptocurrency for $8,000 and it is now worth 20,000.
From David’s point of view, he received $20,000, and his basis in his Bitcoin that he traded with $10,000. That means David would have a gain of $10,000.
Alternatively, Michelle had cryptocurrency that she purchased for $8000, and received bitcoin worth $15,000 dollars in exchange. Therefore, Michelle would have a gain of $7000.
Thereafter going forward, David’s basis and his cryptocurrency would be $20,000, and Michelle’s basis in her cryptocurrency would be $15,000.
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 have to report foreign held cryptocurrency?
FinCEN and the IRS are not clear. 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 exist where 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 with reporting or non-reporting cryptocurrency,
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?
If you are already out of compliance for not properly reporting or paying tax involving your cryptocurrency, you may consider getting into compliance before it is too late.
Golding & Golding, A PLC
We have successfully represented clients in more than 1000 streamlined and voluntary disclosure submissions nationwide, and in over 70-different countries.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.