Internal Revenue Service (IRS) sent a notification to Bitcoin holders. At the end of June, the governmental agency sent letters to more than 10,000 holders of the famous crypto-currency, with the warning that they might have violated the federal tax laws.
This shouldn’t be a surprise to anyone, but surely it will be a headache for taxpayers and tax professionals that haven’t keep track of the digital currency in the past.
The good news is that still is not too late to start working on it. The bad news, is that the days when you could say you didn’t know about the crypto-currency tax laws have come to an end.
First, the confusion was because few people knew how to deal with the tax side of Bitcoin. At the end of 2013, just when cryptos were starting to be recognized and Bitcoin were valued just at USD $650, most of the banks, tech companies and accounting firms were doing efforts to determine if cryptocurrencies had to be taxed as a capital asset, stocks or commodities, therefore, being subject to capital gain rates, or as a fiat currency, as are dollars, euros and yen, for which profits are generally taxed as ordinary income.
In March of 2014, the IRS shared a clear guide about virtual currencies, explaining that it would tax the digital assets as a property, instead of as a coin. What followed, were 5 years with endless communications and actions that made it clear that the IRS took the issue of cryptocurrencies seriously.
In November 2016, the agency submitted a “Jhon Doe” Summons for Coinbase, a Bitcoin trading platform, requesting names and other information from everyone who trades with Bitcoin. Then, in the summer of 2018, when the price of Bitcoin had risen above the USD $8,000 mark, the IRS Large Business & International Division launched a compliance campaign on how investors who own Bitcoin are filing their taxes.
It must have been clear then that, what once was the Wild West had become a highly monitored market. However, the warnings sent by the IRS last month took many Bitcoin holders by surprise. The reason, of course, is that many people – even tax professionals – still don’t understand the details about how cryptocurrencies should be taxed.
Of course, we already said that the IRS categorizes cryptocurrencies as property, but keeping tax records for this peculiar type of property is not as easy to do as with other assets. First, the price of Bitcoin is highly volatile. In July of this year, the price of Bitcoin was USD $12,000, which is three times the value it had in December 2018.
To properly keep track for the value of Bitcoin, the person who buys it must keep records of its value on the day they bought it, as well as the day they sold it, and also take into account the different tax branches and other variables that can impact the total due to the IRS. For those who are frequently making transactions with Bitcoin, these calculations can be exponentially complicated.
Luckily, the IRS recognizes this complexity, and even cryptocurrency investors who have received letters still have time to put their records in order. To help you get started, the following is a general introduction on how virtual currency taxes will affect the three main types of cryptocurrency holders.
Many crypto miners have the mistaken impression that they are only taxable on the amount it costs them to mine Bitcoin. However, according to the IRS, when a Bitcoin is mined, the miner must record the value of the asset at the time of mining, and subsequently treat that value as an income.
Miners engaged in a trade or business are subject to ordinary income, plus self-employment taxes. The value of the crypto-currency becomes the tax base, and if you exchange or use that Bitcoin later, you must include in the income the value of what you get, less that tax base. That requires burdensome record keeping, which many Bitcoin miners are not currently prepared to do, but that they require to comply with the IRS.
Vendors accepting Bitcoin as a payment method
In May 2019, AT&T announced that it would begin accepting Bitcoin, which could be an omen of the future of electronic commerce. But, not all companies are equal. A large corporation such as AT&T has armies of accountants and accounting firms to keep track of these transactions. Most, if not all, small businesses can’t afford that.
Take, for example, a small retailer or a consultant that starts accepting Bitcoin. When that small business receives the crypto-currency, that value is included in the income of the business. But, from that moment, they will need to have a record of their tax base for the Bitcoin they receive.
To make clear the previous point, if a company sells a good valued at 1 Bitcoin, whose value at that moment is USD $ 5,000, but then uses that Bitcoin to buy something a year later, when the price of Bitcoin rose to USD $10,000, now he will have a reportable profit of USD $ 5,000. It’s easy to see how confusing it can be for a business that does not have the resources to employ a full-time accounting team to keep a daily record of the value of its digital assets.
Although there are different types of cryptocurrency investors, the principle for all of them is the same: investors should keep track of when they acquire and how they use Bitcoin.
If an investor enters in the business of selling Bitcoin, it will be taxed differently from an investor who occasionally uses the cryptocurrency market. The returns recognized by Bitcoin sellers will be taxed as ordinary income rates (with a 37% cap). However, those who are not in the business of selling Bitcoin will benefit from lower capital gain rates (with a cap of 20%).
Employers could also start using Bitcoin to pay their employees. If they do, they would add another layer of complexity because Bitcoin would need to be reported in the W-2 form, withholding income taxes, employment taxes, among other taxes.
Whether you have received one of these letters from the IRS or you think you’ll receive it in the future, don’t worry, no matter how threatening it may seem. You can rest assured that the letter is only based on an education process by the IRS, which is introducing the cryptocurrency market.
Practically, the IRS is notifying Bitcoin holders: we know you have them, and you are probably wrongly recording them in your taxes. For this reason, it’s so important that accountants, tax preparers and accounting firms know how to help their clients to make appropriate records for these digital assets.
At GlobalTax, we are prepared to properly record your accounting records, so that you are completely sure that we give the appropriate treatment to your digital assets, thus preventing the IRS warning letters from becoming audit notifications.