There has been a lot of buzz surrounding cryptocurrency and blockchain lately. As the cryptocurrency trend continues to gain traction in everyday life and business, the inevitable topic of taxes and financial impact has steadily trailed.
As of today, tax authorities have yet to release enough guidance for tax professionals to provide taxpayers with adequate answers and sound advice regarding crypto activity. While there are plenty of unanswered questions to theorize and extrapolate, this article will focus on the facts we know and how they affect taxpayers.
Cryptocurrency first surfaced as a result of the 2008 financial crisis that severely damaged consumer confidence in banks and other trusted third parties. A form of electronic cash, cryptocurrencies are a type of decentralized digital currency created to work without a central bank or single administrator.
Bitcoin, ethereum, litecoin, ripple, Zcash, IOTA and many others were created in response to growing consumer demand, after which bitcoin steadily rose in popularity to become the most widely recognized virtual currency. Over the last few years bitcoin has gained significant attention as questions concerning taxes and financial legitimacy swept the world. Smartereum.com reports as of July 2018, the market cap is around $417 billion and is expected by some to reach a cross valuation of $1 trillion.
The tax guidance we know
Virtual currency is treated as property and not as currency, therefore, general tax principles applicable to property (business, investment and/or personal) will apply to cryptocurrency transactions. Furthermore, virtual currency is not subject to foreign currency gain or loss.
Transactions, such as payment for goods or services, are taxable events and the fair market value of the virtual currency on the date of the receipt must be included in calculating taxable income for the tax year.
The exchange of virtual currency triggers a gain or loss, however, whether these gains or losses are capital in nature will depend on whether the virtual currency is a capital asset versus inventory and/or other property in the hands of the taxpayer.
If a taxpayer is involved in cryptomining (validating or authenticating cryptocurrency transactions and updating the blockchain with the transaction information) that person is rewarded with small amounts of cryptocurrency. The IRS views any successful mining as taxable income and the fair market value of the virtual currency received must be included in the taxpayer’s gross income. The IRS treats these net earnings as a trade or business and it is subject to self-employment tax if the mining is not performed as an employee.
The IRS confirmed that a virtual payment with a value of $600 or more (including rent, salaries, wages, annuities and compensation) must be reported to the IRS and the payee accordingly. Further, payments greater than $600 made to independent contractors are also required to be reported on Form 1099-MISC using the fair market value on the date of payment.
Virtual currency payments are subject to backup withholding, similar to payments made in property. This means that the payer must request appropriate information (such as taxpayer identification numbers) from the payee, otherwise backup withholding from the payment is required. In certain cases the IRS may send a notification that such withholding is required.
As with any tax law, there are consequences for not properly following the rules. The IRS warns that failure to treat virtual currency transactions properly (as specified by IRS Notice 2014-21 on March 25, 2014) will result in penalty.
As the crypto market cap continues to grow, so does the need for increased guidance and regulation. While there remains vast uncertainty with respect to cryptocurrency, one thing remains clear — it’s here to stay. Be sure to stay informed and stay abreast of new regulations and updates as tax guidance continues to shed light on this highly intricate topic.