Crypto has become mainstream. Consequently, there is no denying the fact that the IRS has a vested interest in crypto transactions and will be taking steps to regulate them.
For example, you can use bitcoin to buy things you wouldn’t think of. To find out, try googling “What can I buy with bitcoins?” You will get hundreds of thousands of results.
Using crypto for your finances can pay off massively, but you need to know how it’s going to affect your taxes.
The booming price and ever-increasing acceptance of bitcoin as a form of payment is now creating tax implications for those using it as their currency. This article covers all you need to know. Ready?
What Is Cryptocurrency?
Cryptocurrency is a digital currency either issued by a software developer or mined by a group of people. These cryptocurrencies can be traded for goods and services, accepted as payment from willing buyers and sellers, and aligned with a good cause.
Bitcoin, for example, can be used to transfer money without involving banks. You could also store it by downloading an appropriate storage software or investing in it if you feel that gambling is wrong. Bitcoin is the most famous example of a cryptocurrency. Unlike conventional currencies such as the U.S. dollar or euro, cryptocurrencies are not regulated by any particular entity, so they come without any responsibility or accountability, making them comparably more risky than using fiat money.
The most popular way to buy cryptocurrency such as bitcoin is through cryptocurrency ATMs or online exchanges. These generally charge a small fee for each transaction. Some businesses are accepting cryptocurrencies to avoid the transaction fees of traditional online payment services.
Cryptocurrencies are basically unregulated, but every single bitcoin/cryptocurrency transaction is digitally recorded on the blockchain. Anyone can try to get a copy of the blockchain to trace transactions.
Distributed ledger technology relies on a number of digital systems that, in contrast to a centralized database, record and share transactions independently.
IRS Wants to be Informed about Your Crypto Transactions
In 2020, the new IRS Form 1040 asks you to state whether you have sold, sent, exchanged or otherwise acquired any digital currencies during the year. Have you?
If you answered Yes, please check the “Yes” box.
That this question appears on page 1 of Form 1040 indicates to me that the IRS is serious about enforcing compliance with the applicable rules.
What is a Cryptocurrency Transaction?
To clarify the rest of this article, we will be using “cryptocurrency” interchangeably with “virtual currency.” The IRS takes the position that cryptocurrency is “property” for federal income tax purposes.
The IRS says that if you trade one type of crypto for another or for USD, you might have to pay taxes on the trade. If you fail to report crypto transactions to the IRS and get audited, you could lose not only the money involved but also any penalties and interest as well as jail time in extreme cases.
There is also a fair market value (FMV) calculation to undertake when it comes to cryptocurrency transactions. First, the FMV will be determined in U.S. dollars, then on the date of receipt and then when it is used with another type of payment like fiat currency or goods bought
The values of the most popular cryptocurrencies are listed on exchanges. Here’s an example, bitcoin and many other cryptos are listed on Coinbase. At the time we began this article, one bitcointranslated into $57,182 according to the Coinbase exchange. So, if you bought one bitcoin with U.S. dollars at that price, your basis in the bitcoin for federal income tax purposes would be $57,182.
When you exchange cryptocurrencies, including the US dollar, other currency or service for your initial transaction, you can experience a taxable gain or loss. This is similar to stock trading on the stock market and the transactions are recorded as such.
Here is a short summary of how crypto payments work in the context of the US tax system.
If you’re using cryptocurrency to pay wages, then the value of that currency counts as taxable income for federal income tax purposes, FICA taxes, and the FUTA. This is similar to any other kind of wages paid to employees where you must report wages made to them and
If you want to use cryptocurrency like Bitcoin or Ethereum to pay independent contractors for their work, you’ll need to include the FMV of the currency in their self-employment taxes. You must report payments made to this contractor on Form 1099-NEC if the payments are at least $600.
If you net your expenses to the revenue generated by the cryptocurrency, you may have a tax gain or loss. This happens when the difference in values is more than $600 over a rolling 12-month period. Since you’re not in the business of buying and selling cryptocurrencies, any gains or losses will be classified as capital gains or capital losses (and will be short-term or long-term, depending on how long you held the cryptocurrency.)
It’s best to seek professional advice from a CPA or to guide you in your financial decisions.
Talk to your professional advisor today.