In the summer of 2019, the IRS mailed a series of notification letters to taxpayers who owned virtual currency. These letters informed taxpayers that the IRS was aware of their virtual transactions and expected them to submit amended tax returns if they had not included virtual income and transactions on their 2018 returns.
Previously, the IRS was unable to track virtual currency transactions, so these letters came as a surprise to many taxpayers. If you received one of these letters or are new to virtual currency, please keep reading to learn how this might affect your taxes.
- Virtual currency is digital money connected to a digital recordkeeping ledger (Blockchain) that ensure honest and private transactions.
- The IRS has begun tracking virtual currency transactions and income and now requires owners to report it on their taxes.
- Owners must convert virtual currency to its fair market value (FMV) at the time of acquisition and report that number to the IRS.
- Failure to accurately report virtual currency could result in penalties or criminal prosecution.
How Does Virtual Currency Work?
Virtual currency is a type of digital currency. However, digital currency can refer to digital banking transactions, whereas virtual currency usually isn’t regulated by a bank or other centralized third-party. Instead, virtual currency is recorded in a digital ledger called a Blockchain, which privately records transactions between parties.
Many people use virtual currency for peer-to-peer payments and payments for the purchase of goods and services. Virtual currency in a Blockchain ledger can facilitate these private transactions between friends and strangers alike.
How Does the IRS Regard Virtual Currency?
According to the IRS, “for federal tax purposes, virtual currency is treated as property.” As such, tax rules that apply to typical property transactions (like selling your car) also apply to virtual currency transactions.
The IRS considers virtual currency a type of intangible personal property. Other examples include trademarks, stocks, bonds — and anything else that has monetary value but no physical form.
The IRS expects taxpayers to report virtual currency income and applicable transactions on their taxes just like with other types of property.
What Does The Virtual Currency Crackdown Mean for Me?
If you use virtual currency to collect income and perform transactions, there are several things to keep in mind in order to avoid the IRS recent crackdown on this emerging technology.
You Need to Record Your Virtual Currency Income Accurately
Accurately reporting virtual income and transactions isn’t as easy as copying and calculating numbers from your W–2. The digital and unregulated nature of virtual currency transactions makes keeping track of your gains and losses somewhat challenging.
Furthermore, you can’t just write that you made 500 Bitcoins in income on your 1040 next to your total wages, salaries, and tips. You’ll have to convert each virtual currency type you own into its fair market value in dollars. That’s the FMV of the currency at the time you received it — not at the time you report it. In other words, if you have Bitcoin currency, Ethereum, and Litecoin, you’ll have to calculate each currency’s FMV in U.S. dollars.
Failure to Accurately Record Transactions Can Result in Penalties
The IRS can track and record certain virtual currency transactions. And while their methods aren’t perfect, they can determine which taxpayers have excluded virtual currency from their filing with some degree of accuracy.
Like any other type of tax liability, failing to report income from virtual currency transactions accurately can result in additional taxes, penalties, and interest. In extreme cases, taxpayers could even be subject to criminal prosecution.
If you have unpaid taxes from virtual currency, it’s always best to come forward and voluntarily file an amended return before the IRS begins its own collection efforts.
You Need to Know Which Virtual Transactions Must Be Reported
- Receiving virtual currency as payment for goods or services
- Mining virtual currencies
- Gifting virtual currency
- Trading or exchanging virtual currency
- Spending virtual currency
Contact S.H Block Tax Services With Your Virtual Currency Questions
Accurately converting your virtual currency to U.S. dollars is a complex process that requires careful recordkeeping. Amending a tax return or filing a delinquent tax return because you failed to file your virtual currency income accurately can be time consuming, confusing, and potentially very expensive.
To ensure compliance and accuracy with your virtual currency when filing your taxes, please contact the skilled and experienced tax professionals at S.H. Block Tax Services. We can help you determine how to file your virtual currency transactions and income. We can also help you amend any previously filed returns.
Aqui, K. (2014). Notice 2014-21. Internal Revenue Service – Income Tax & Accounting. Retrieved from https://www.irs.gov/pub/irs-drop/n-14-21.pdf
The content provided here is for informational purposes only and should not be construed as legal advice on any subject.