U.S. Tax Implications of Transactions with Virtual Currency
July 19, 2018Share:
By: Michael White, CPA
Virtual currencies (VC) such as Bitcoin are making headlines. Just because these currencies have a “virtual” nature there are potential “real” U.S. tax consequences and reporting requirements. The Financial Crimes Enforcement Network (FINCEN) bureau of the U.S. Treasury defines VC as “a medium of exchange that operates like a real currency in some environments but does not have all the attributes of real currency.” VC does not have legal tender status in any jurisdiction. Virtual currency (VC) references discussed here refer only to virtual currencies that have an equivalent value in real currency commonly known as “convertible” virtual currency. Some of the potential tax consequences and reporting requirements of VC transactions under U.S. tax are:
• VC is treated as property (intangible asset). Sales or exchanges of VC for other property trigger a taxable event. The classification of the gain or loss (ordinary or capital) depends on how the taxpayer holds the VC. Losses may be limited. The Tax Cuts and Jobs Act 2017 eliminated exchanges of personal property from like-kind exchange treatment and deferral of gain.
• Many everyday items can be purchased with VC. The IRS says there are two transactions. First you sell the VC then you use the sales proceeds for the purchase. For example, you take that first-class dream trip to Europe and you pay for it with VC. The cost of the trip is valued at $8,000 USD. You pay for it with VC that you bought back in 2016 for $500. Your taxable gain is $7,500 and both a federal and potential state tax liability may result. Technically, all sales and exchanges of VC must be reported on your U.S. tax return no matter how small, e.g. purchase a sandwich with VC and it goes on your tax return. What a potential reporting nightmare.
• Ignoring the IRS rules is risky. Like most everything else in the “virtual” world, a record is stored somewhere for the IRS to examine and determine your VC transactions. The IRS recently won a landmark case against Coinbase that will give them access to all VC transactions over $20K during 2012-2015.
• VC payments received by independent contractors are taxable for income tax and generally for self-employment (SE) tax. Form 1099 must be issued and is subject to backup withholding.
• Paying employees in VC still requires normal payroll reporting and withholding.
• Thinking about “mining” VC (using computer resources to validate VC transactions and maintain the public VC transaction ledger)?
– Fair market value on date of receipt is gross income
– If your “mining” constitutes a trade or business and you are not an employee, any net earnings will be subject to SE tax rules.
• Another wrinkle was thrown into the fray in 2017. Bitcoin announced a “dividend” of Bitcoin Cash. For tax purposes this is other income with no qualified dividend tax treatment. It is also taxable to the recipient even if they did not claim it (constructive receipt rules apply).
• Unless reasonable cause is established, normal civil penalties for failure to comply with U.S. tax laws will apply and criminal investigations can be implemented if warranted.
• More VCs are starting up and many are generating huge increases in the investment. Amidst the glitz and glamour and the promise of wealth, Uncle Sam and the state tax authorities have their hand out grabbing their share. An industry surpassing $600 billion will be on their radar.
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