Tax Time and Virtual Currency was published by JD Supra on 4/9/19.
Virtual Currency (VC) investors continue to have accounting challenges at tax time. They are seeking to
better understand and comply with their U.S. tax regulatory obligations when using VC. That said, IRS has not issued any additional guidance that Taxpayers may rely upon to better understand their U.S. tax regulatory obligations. Despite the lack of clarity, IRS stated in March 2018 that: “Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest. In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000”
VC investors ought to understand that IRS continues to expand its enforcement activities without issuing any further guidance for Taxpayers:
- IRS has taken enforcement actions as evidenced by the IRS utilizing its John Doe Summons authority to seek the records of approximately half a million Americans who held VC between 2013 and 2015.
- The IRS Large Business and International division launched a new compliance campaign focusing on non-compliance related to VC.
- IRS announced that it would not be creating a special voluntary disclosure program to address Taxpayer’s tax non-compliance related to VC as evidenced in the IRS new release dated July 2, 2018 where the IRS states: “U.S. persons are subject to tax on worldwide income from all sources including transactions involving virtual currency. IRS Notice 2014-21 states that virtual currency is property for federal tax purposes and provides information on the U.S. federal tax implications of convertible virtual currency transactions. The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. The IRS will continue to consider and solicit Taxpayer and practitioner feedback in education efforts, future guidance, and development of Practice Units. Taxpayers with unreported virtual currency transactions are urged to correct their related tax returns as soon as practical. The IRS is not contemplating a voluntary disclosure program specifically to address tax non-compliance involving virtual currency”.
IRS issued its last VC Notice in April 2014 (Notice 2014-21)
The notice was issued to provide guidance and it was released in the form of frequently asked questions to describe how existing general tax principles apply to transactions using virtual currency.
- For federal tax purposes, virtual currency is treated as property.
- Virtual currency is not treated as a currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
- A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.
- The basis of virtual currency that a taxpayer receives as payment for goods or is the fair market value of the virtual currency in U.S. dollars as of the date of receipt
- For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars.
- Taxpayers will be required to determine the fair market value of virtual currency in U.S. dollars as of the date of payment or receipt.
- If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain.
- The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.
- A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer.
- When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.
- If a taxpayer’s “mining” of virtual currency constitutes a trade or business, and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax.
- A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
- A person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services is required to report that payment to the IRS and to the payee on Form 1099-MISC, Miscellaneous Income.
- The payment recipient may have income even if the recipient does not receive a Form 1099-MISC.
- Payments made using virtual currency are subject to backup withholding to the same extent as other payments made in property.
- Payors making reportable payments using virtual currency must solicit a taxpayer identification number (TIN) from the payee. The payor must backup withhold from the payment if a TIN is not obtained prior to payment or if the payor receives notification from the IRS that backup withholding is required.
- A third-party settlement organization is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third-Party Network Transactions, if, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200, and (2) the gross amount of payments made to the merchant exceeds $20,000.
In summary, IRS Notice 2014-21 provides the following clarity regarding virtual currency:
- Bitcoins are not a currency. They are considered personal property and taxed as a capital asset.
- If a Bitcoin is converted into currency and there is a gain, it is subject to capital gain.
- If goods or services are purchased with Bitcoins, the Taxpayer must also account for the gains.
- A Taxpayer that receives Bitcoin as payment for goods or services must include the fair market value of the digital currency received measured in USD in the gross income on the date of the receipt.
- Digital currency that is held and then sold at a gain is subject to either long- or short-term capital gains tax.
- A Taxpayer, who holds digital currency for sale in a trade or business, is subject to ordinary gain or loss upon sale.
- Digital currency is recognized income immediately at the fair market value. This income could be subject to self-employment tax.
Tax Cut Jobs Act (TCJA) amends Internal Revenue Code Section 1031: like-kind exchanges
The TCJA amends Section 1031 such that “real property” is the only type of property eligible for like-kind exchanges after December 31, 2017.
VC investors that relied on prior law to exchange one VC for another VC without paying taxes and or creating tax obligations can no longer treat the transaction as a like-kind exchange under the TCJA.
For U.S. Federal Income Tax purposes, Virtual Currency (VC) is treated as property. As a result, a VC investor ought to keep a very close watch on potential net short term capital gains (realized gain if VC is held one year or less or long-term capital gains (realized gain if VC is held for more than a year). Net short-term capital gains are treated like ordinary income for tax purposes and taxed at the Taxpayer’s highest marginal federal income tax bracket. If a VC investor experiences a loss, net capital loses are capped at $3,000 a year.
Don’t be a Victim of your Own Making
Taxpayers ought to understand what constitutes a VC taxable event in order to better fulfill their obligations at tax time:
- Taxable events related to VC occur if the VC Holder “does something” after obtaining the VC. Meaning: Taxpayers don’t owe taxes if they bought VC and just held on to it (not a taxable event).
- Taxpayers may owe taxes if they sell or exchange VC, exchange it for another VC or use it to buy goods or services (all reportable events).
If you are Taxpayer investing, making payments or receiving payment in virtual currency, consult your tax specialist. Taxpayers may be subject to penalties for failure to comply with tax laws. Underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under Section 6662 of the Internal Revenue Code (IRC). Failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under Section 6721 and 6722 of the IRC. There are reporting requirements even if the Taxpayer does not receive a Form-1099.