Bitcoin Tax tips and the IRS

bitcoin-tax-tipsThere is no doubt that more attention is being garnered by the IRS with regard to Bitcoin, Ethereum and other cryptocurrency transactions.  According to Google Trends search data, the rising price of Bitcoin and other digital currencies, the increasing interest, popularity and growth will only continue.

Due to this significant interest, there are many questions regarding the tax consequences of purchasing, selling, exchanging and holding digital currencies.  Be aware of these many Bitcoin aspects as you don’t want to be caught having tax problems with the IRS.

How does Bitcoin or cryptocurrencies work?

Cryptocurrencies are digital or virtual currencies that can be shared instantly online, free from government or corporate interference, also known as decentralized blockchain.  Money is made by buying and selling Bitcoin on a crypto currency exchange.  In doing so, an investor converts wealth from bitcoin to U.S. dollars to other national currencies, back to dollars or Bitcoin.

Some of the advantages of cryptocurrencies, such as Bitcoin, include:

  • User anonymity (actually bitcoin keeps all transactions on a ledger so IRS can use blockchain to follow transactions)
  • No third party interruptions (unless you use  a third party wallet)
  • Non-taxable purchases
  • Low transaction fees  (bitcoin fees are getting higher)
  • Not bound by exchange rates or interest rates
  • Mobile payments
  • Transactions take place at the same speed, regardless of where sender and receiver are located (but dependant on the miners)
  • Cannot be counterfeited and transactions cannot be reversed arbitrarily

See Investopedia: https://www.investopedia.com/ask/answers/100314/what-are-advantages-paying-bitcoin.asp; See also https://steemit.com/cryptocurrency/@tobiascrypto/digital-currency-in-black-and-white.

How is Bitcoin taxed?

Bitcoin is definitely global, but taxation issues differ from country to country.  In March of 2014, the IRS recognized virtual currency by publishing guidance found in IRS Notice 2014-21.  It established that Bitcoin and other cryptocurrencies are treated as property (not as currency) for U.S. Federal tax purposes and that general rules for property transactions apply.

Due to this classification, everyone that deals with Bitcoin will be labeled basically as an investor and must deal with the complex and sometimes grueling reporting requirements and significant ensuing taxes for its use.

Thus, the IRS is treating the income or gains from the sale of a virtual currency, such as Bitcoin, as a capital asset, subject to either short-term (ordinary income tax rates) or long term capital gains tax rates, if the asset is held greater than twelve months (15% or 20% tax rates based on income).

Other general tax principles apply to bitcoin in the following ways as cited by the IRS:

  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

Bitcoin Tax tips for Reporting to the IRS

For most investments, we receive a 1099 showing taxable gains.  This is where things get dicey.  For Bitcoin and cryptocurrency transactions, there are no official notices given.  It is up to the individual investor to report the transactions.  Taxpayers must generally file form 8949 along with 1040 Schedule D (see also Schedule D instructions) when reporting Bitcoin and other cryptocurrency transactions.

Tax reporting compliance is extremely low, however.  Case in point, out of 480,000 investors utilizing a website called Coinbase, only 802 investors reported their gains or losses to the IRS between 2013-2015.  Due to this lack of reporting, the IRS was able to force Coinbase via Court Order to hand over 14,000 of these investor records from 2013-2015.

So, be sure to report as the IRS is becoming very aware of this non-compliance where you could potentially be viewed as engaging in tax fraud.

What does the future hold for Bitcoin

The IRS is definitely tweaking more of the IRS code to take advantage of Bitcoin and other cryptocurrencies.  As described in this Fortune article dated December 21, 2017, the IRS closed the following “loophole” with regard to cryptocurrencies:

“The tax act in Sec. 13303 amends IRC Section 1031 (a)(1) to delete “property” and replace it with “real property” … So, you can see that now I can no longer take the position that my Bitcoin to Litecoin exchange was a like kind one under Sec. 1031, and I have to recognize the gain when I do it.”

Unfortunately, the IRS wants its cut so be sure to keep abreast of where they stand on cryptocurrencies.  Be sure to look into their latest development:  IRS deployment of special software to identify Bitcoin tax cheats.

Cryptocurrency investments, such as bitcoin, are no doubt risky and highly volatile.  It is important to stay ahead of the game and especially the tax changes in this area and seek the advice of a knowledgeable tax attorney.  The San Diego Tax Attorneys at Delia Law have many years of tax experience and will competently represent you before the IRS.  Please call for a no-cost tax attorney consultation at (619) 639-3336. We look forward to helping you.

This Bitcoin tax tips blog post is not intended as legal advice and should be considered general information only.

 

Keywords:  Bitcoin, cryptocurrencies, digital currency, virtual currency, tax problems

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