Wink Inc.
Enrolled Agents
America’s Tax Experts
®
Wink Tax Services
Cryptocurrencies and Taxes
Highlights:
•
Virtual Currency
•
Valuation
•
Transactions
•
Character of the Gain or Loss
•
Foreign Currency Transactions
•
Foreign Bank and Financial Account (FBAR) Reporting
•
Payment for Goods & Services
•
Acquiring Virtual Currency
•
Virtual Currency Mining
•
Employee Payments
•
Independent Contractor Payments
As our world has become more and more “digital,” it was only a matter
of time before cryptocurrencies were developed. One of the first of
these virtual currencies was Bitcoin, and the Bitcoin network came
online in 2009. Since then, additional cryptocurrencies have been
developed.
Cryptocurrencies are generally utilized for transactions by tech-savvy
individuals and have a comparable value in real currency or take the
place of real currency. These virtual currencies can be purchased with
or exchanged into U.S. dollars, euros, and other real or virtual
currencies.
Valuation – The value of a virtual currency is based upon market value,
i.e., what a willing buyer will pay a willing seller – much like trading in
stocks. On February 15, 2018, when this article was written and
according to Oanda (an online currency converter), a Bitcoin, one of
the more popular virtual currencies, was worth $9,025, and one was
worth $995 one year earlier.
It took several years for the IRS to come up with guidance on how to
deal to transactions involving virtual currencies. It finally issued Notice
2014-21 determining that virtual currency is treated as property and
that the general tax principles applicable to property transactions apply
to transactions using virtual currency. This can best be illustrated by
example.
Example A: Taxpayer buys Bitcoins (BTC) to use when making online
purchases without the need for a credit card. He buys one BTC for
$2,425 and later uses it to buy goods (BTC was trading at $2,500 at
the time he made his purchase). He has a $75 ($2,500 − $2,425)
reportable capital gain. This is the same result that would have
occurred if he had sold the BTC at the time of the purchase and used
U.S. dollars to purchase the goods. This example points to the
complicated record-keeping requirement to track BTC’s basis. Since
this transaction was personal in nature, no loss would be allowed if the
value of BTC had been less than $2,425 at the time when the goods
were purchased.
Example B: Taxpayer buys Bitcoin (BTC) as an investment. The same
rules apply as for stock transactions. Gains are taxable in the year
realized, and any resulting loss, when combined with the other capital
transactions for the year, are limited to $3,000 ($1,500 if a married
taxpayer filing separate).
Character of the Gain or Loss – The character of the gain or loss
generally depends on whether the virtual currency is a capital asset in
the hands of the taxpayer. A taxpayer generally realizes capital gain or
loss on the sale or exchange of virtual currency that is held as a capital
asset. For example, stocks, bonds, and other investment property are
generally capital assets. A taxpayer generally realizes ordinary gain or
loss on the sale or exchange of virtual currency that he or she does not
hold as a capital asset. Inventory and other property held mainly for
sale to customers in a trade or business are examples of property that
is not a capital asset.
Foreign Currency Transactions – Under currently applicable law, virtual
currency is not treated as currency that could generate foreign
currency gain or loss for U.S. federal tax purposes.
Foreign Bank and Financial Account (FBAR) Reporting – The IRS has
stated a few years ago that virtual currency transactions need not be
reported for purposes of Foreign Bank and Financial Account (FBAR)
reporting. But the IRS cautioned that its position could change in the
future. However, the IRS has not issued any announcements regarding
a change in its position on FBAR filings for years through 2017.
Payment for Goods & Services – A taxpayer subject to U.S. taxation
who receives virtual currency as payment for goods or services must,
in computing gross business income, include the fair market value of
the virtual currency, measured in U.S. dollars, as of the date that the
virtual currency was received.
Acquiring Virtual Currency – One can go to online exchanges and
purchase virtual currency. But care should be taken to make sure the
exchange is reputable. Once you have the virtual currency in your
online wallet, you are free to spend it with anyone who accepts that
form of currency.
Virtual Currency Mining – Mining is a term used to describe how
cryptographic information distributed within a virtual currency network
is secured, authorized, and approved. In essence, it is the processing
of payments that have taken place once they occur. It takes the place
of banks, merchants’ accounts, and clearing houses like Visa. It
essentially eliminates all of the third parties’ cuts of income from the
transaction. It involves complex mathematical logarithms that need to
be solved, and the mining process completes this task autonomously.
For individuals who mine virtual currency, it is a trade or business, and
they are subject to self-employment tax.
Apparently, virtual currency miners are also subject to Form 1099-K
filing requirements if their transactions rise to the reporting threshold.
In general, a third party that contracts with a substantial number of
unrelated merchants to settle payments between the merchants and
their customers is a third-party settlement organization (TPSO). A
TPSO is required to report payments made to a merchant on a Form
1099-K, Payment Card and Third-Party Network Transactions. If, for
the calendar year, both (1) the number of transactions settled for the
merchant exceeds 200 and (2) the gross amount of payments made to
the merchant exceeds $20,000, then 1099-K filing is required.
Employee Payments – If an employee is paid in virtual currency, then
the fair market value of the virtual currency, measured in U.S. dollars,
paid as wages is subject to federal income tax withholding, Federal
Insurance Contributions Act (FICA) tax (Social Security and Medicare
A), and Federal Unemployment Tax Act (FUTA) tax and must be
reported on Form W-2, Wage and Tax Statement. The U.S. government
doesn’t accept virtual currency for tax payments.
Independent Contractor Payments – The fair market value of virtual
currency received for services performed as an independent contractor,
measured in U.S. dollars as of the date of receipt, constitutes self-
employment income to the independent contractor and is subject to
the self-employment tax. Payments are subject to the normal 1099-
MISC reporting requirement when the payments for the year measured
in U.S. dollars are $600 or more.
IRS Enforcement Actions – Because fewer than 900 taxpayers
reported virtual currency gains and losses each year on their tax
returns from 2013 to 2015, the IRS is stepping up enforcement of the
rules. Recently, the IRS won a court’s approval for a summons to
obtain account and transaction information on more than 14,000
customers from Coinbase, a company that services buyers and sellers
of Bitcoins. Based on the success in the Coinbase case, the IRS will
likely expand its efforts to obtain information about cryptocurrency
account owners from other companies dealing in Bitcoins and similar
virtual currencies.
Also, beginning with 2018 returns, Sec. 1031 tax-deferred exchanges
will only apply to real property; thus, investors in virtual currency who
trade one type of virtual currency for another will be required to report
their capital gains/losses and won’t be able to use the 1031 tax-
deferral rules.
If you are investing, trading, or dealing in virtual currency and have
any questions about how those activities will affect your tax situation,
please give this office a call.
Wink Inc. Enrolled Agents | 2701 Troy Center Dr, Ste 255 |
Troy | Michigan | 48084 | Tel: 248-816-1220 | TF: 800-276-8319
| Text: 248-800-6013 |