Cryptocurrencies (also called altcoins) have been in the news a lot over the past year or so, and while thousands of people have been cashing in on their investments in digital currencies like Bitcoin, many of them haven’t considered the tax ramifications of those sales. The IRS considers cryptocurrencies to be property, which means a variety of taxes likely apply to your altcoin transactions, including capital gains.
Let’s examine the tax implications of cryptocurrency further, including potential criminal action for non-disclosure, and determine the best course of action for filing next year’s taxes.
What Is Cryptocurrency?
At this point, most people have heard of cryptocurrency, but many are still confused about what it is and how it works. We define cryptocurrency as any virtual currency that operates as a medium of financial exchange and uses the science of cryptography to secure the digital funds. According to CoinTelegraph, the cryptocurrency world consists of virtual currencies that are limited entries in a database which no one can change unless specific conditions are filled.
The ideas behind cryptocurrency have been around for a while. When the internet became a household technology in the 1990s, early cryptocurrencies like DigiCash and Beenz quickly arrived on the scene. However, these early systems failed because they lacked adequate measures for security and consumer protection, and those early missteps led most people to abandon the concept of cryptocurrency altogether.
That changed in 2009 when an anonymous group of programmers who referred to themselves as Satoshi Nakamoto developed and introduced Bitcoin, which they defined as “a peer-to-peer electronic cash system.” One of the main innovations of Bitcoin was its completely decentralized system, which didn’t rely on third-party servers. By incorporating blockchain technology, Bitcoin eliminated the potential for double-spending, which is a fraudulent technique for spending the same portion of digital currency twice. The blockchain is essentially a peer-to-peer crowdsourcing ledger that details every transaction that has ever happened or will happen and makes the information available to the public.
How Will My Cryptocurrency Earnings Affect My Taxes in 2019?
Previously, proceeds from cryptocurrency sales weren’t high on the IRS’ list of investigative priorities, especially since only a few hundred taxpayers reported their crypto gains each year. However, as currencies like Bitcoin, Litecoin, and Ethereum became more popular (and profitable) in 2017, the IRS began to take notice and go after people who failed to disclose cryptocurrency profits. Generally, when the IRS begins cracking down on a specific issue, you should take extra care to disclose anything related to that issue on your returns to avoid potential fees, penalties, and even criminal charges.
Unfortunately, the IRS has been uncharacteristically vague when discussing how it treats cryptocurrency profits. The agency issued its only statement on the topic in 2014 and hasn’t updated the language since. The IRS’ current guidelines state that cryptocurrency is treated as property rather than currency, which means whether taxpayers are selling, spending, or exchanging cryptocurrency, they need to apply a different line of thinking regarding their altcoin profits.
Let’s examine the tax implications for different types of cryptocurrency transactions:
- Initial offerings: Considered income for both individuals and businesses
- Trading: Results in either capital gains or losses; capital losses could offset capital gains and minimize tax liability
- Exchanging: Altcoin exchanges are treated as a sale that results in either capital gains or losses.
- Receiving payments: Cryptocurrency payments received as salary or in exchange for a product or service are considered income.
- Air drops: The day of the drop, these transactions are treated as ordinary income, but their value will vary and will be considered a capital gain or loss when sold or exchanged.
- Mining: Considered income with a value tied to the fair market value of the coin the day it was mined
- Spending: Results in either short- or long-term capital gains or losses
Navigating the Cryptocurrency Maze
Here are three tips that can help you avoid taxation troubles if you’re buying and selling cryptocurrencies.
1.) Always Self-Report
Unlike proceeds from selling stocks and bonds, you probably won’t receive a 1099 for your cryptocurrency earnings. For example, if you use the popular exchange Coinbase, you won’t receive a statement unless you’ve made $20,000 from sales and completed at least 200 transactions. So, unless you’re a major player in the cryptocurrency world, you should expect to be responsible for self-reporting all your gains and losses.
However, in the likely event no one else is reporting your cryptocurrency gains to the IRS, you are still required to pay taxes on them. You should never try to evade taxes; the IRS will most likely discover your deception, which will result in fees, penalties, or even criminal charges.
2.) Keep Track of Capital Gains (and Losses)
As mentioned above, many cryptocurrency transactions could result in capital gains taxes since the IRS views altcoins as property rather than income. This means you could end up paying significantly more taxes if you’ve realized a capital gain, but it may lower your tax bill if you’ve suffered a loss.
When reporting cryptocurrency for tax purposes, you should state when you purchased the currency, what you paid for it, when you sold it, and what you received for it. The basis (or purchase price) will be used to determine capital gains or losses. For further assistance, you can visit bitcoin.tax, where you can determine how much you owe and complete a Schedule D (1040) for capital gains and losses from cryptocurrency sales.
3.) Keep Accurate and Timely Records
Don’t wait until the last minute to check old emails or waste time scrounging around the junk drawer for past statements and receipts. Instead, keep an accurate ledger of all cryptocurrency transactions and include information about dates, costs, and trade partners. You should also withhold an appropriate percentage from your proceeds to help cover potential tax payments and/or liabilities related to cryptocurrency. You’ll thank yourself when tax season rolls around.
S.H. Block Is Happy to Discuss Your Cryptocurrency Tax Questions
At this point, the popularity of cryptocurrencies is still a relatively new phenomenon, and the tax rules regarding cryptocurrency profits will undoubtedly evolve. But we’ve already helped several clients gain better insight into how they’ll be impacted next tax season, and we look forward to potentially assisting you with similar tax queries.
Please contact us at (410) 793-1231 or complete this brief form to schedule a free consultation where we can discuss your cryptocurrency investments and any other tax issues you might have. Statutes of limitations apply, so please reach out today!
Bahney, A. (2018, March 26). 4 things to know about your cryptocurrency at tax time. CNN Money. Retrieved from https://money.cnn.com/2018/03/26/pf/how-to-pay-taxes-on-cryptocurrency/index.html
Villamena, V. (2018, January 30). Cryptocurrency and taxes: What you need to know. CNBC. Retrieved from https://www.cnbc.com/2018/01/30/cryptocurrency-and-taxes-what-you-need-to-know.html
What is cryptocurrency. Guide for beginners. (2018). CoinTelegraph. Retrieved from https://cointelegraph.com/bitcoin-for-beginners/what-are-cryptocurrencies#future-of-cryptocurrency
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