Taxation of Bitcoins and other Virtual Currency

“Stay away from it. It’s a mirage, basically. In terms of cryptocurrencies, generally, I can say almost with certainty that they will come to a bad ending.”  –  Warren Buffett

Taxation of Bitcoins and other Virtual Currency

Credit: Donald J. Sauder, CPA | CVA

In recent years, The Internal Revenue Service has now issued a decree that all virtual currency transactions are henceforth taxable. This includes Bitcoin, Ethereum, Ripple, Litecoin, Tether, and EOS. Concerningly, to tax advisors in the age of information, many virtual currency users continue to be unaware of the increased non-compliance risks and continue to blissfully transact with any number of virtual currencies absent consideration of IRS tax implications.   

The IRS classifies virtual currency as a digital representation of value, other than a representation of the U.S. dollar or a foreign government authorized currency that functions as a unit of account, a store of value, and a medium of exchange. Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency; and are a digital medium of exchange, such as digital currency and cryptocurrency.

Cryptocurrencies are a type of virtual currency that utilizes cryptography to secure transactions digitally recorded on a ledger, such as a blockchain. Units of cryptocurrencies are generally called coins or tokens.

Fortuitously, the IRS has instituted property tax laws to virtual currencies instead of currency for federal tax purposes. Therefore, in exchanges of one virtual currency for another, while a taxable transaction is subject to propitious capital gains taxes instead of higher ordinary income tax rates.

However, mining activities for virtual currencies and payments received for services from virtual currency payments representing earnings income may be ordinary income tax rates. You join a group of virtual currency miners, and your share of electricity is $10,000, and you receive $17,000 of coin value. You will have $7,000 of ordinary taxable revenues for IRS purposes.

Payments for services as an independent contractor from virtual currency are subject to self-employment income and self-employment FICA taxes. Additionally, wages or salaries paid in virtual currency are per the IRS code remuneration for employment tax purposes and subject to federal income withholding and both FICA and FITA reporting. Since Federal taxes on the IRS form are subject to U.S. dollar currency values, the income you must be recognized is the fair market value of the virtual currency in U.S. dollars when received if you’re receiving payments for services in the virtual currency, you’re advised to keep costs tabulated and tax implication measures.

The IRS continues to closely monitor the growing fields of virtual currency exchanges, and in 2017 they investigated Coinbase. Coinbase’s extensive crypto exchange has almost 6 million registered members and fewer than 1,000 of those filed a tax return for implicit gains on the virtual currency. Following a legal directive, Coinbase delivered a few thousand names to the IRS. A corresponding number of IRS letters were issued to virtual currency account holders issuing a warning. They would be advised to begin tax compliance before an audit as a good faith encouragement. Taxpayers incorporating virtual currency transactions are advised to regularly consult with their tax advisors on increasing tax compliance and regulations to keep apprised of tax law revisions regarding virtual currencies.

Also, paying for services with virtual currencies held as a capital asset, upon the exchange will incorporate a taxable transaction with either a reportable capital gain or loss. Virtual currency received as a gift will not be recognized as income until exchanged or sold. If you cannot substantiate the donor’s basis, your tax basis is zero in the virtual currency property. The capital gain on virtual currency gifts is either the day you receive the gift or the day from documentation substantiating the donors holding period of the virtual assets.

A charitable organization receiving virtual currency donations will attribute such gifts to non-cash contributions and advised to consult with a tax advisor before embarking on such contribution receipts.

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