What The IRS Says About Cryptocurrency InvestmentsUpdated: June 25, 2021
There has been growing interest in cryptocurrency like Bitcoin, Ethereum, and many others. Social media is full of speculators, traders, and celebrities interested in this type of investing and trading and over the years there’s been a fair bit of regulatory interest in crypto as well.
What do veterans, currently serving military, and family members need to know about cryptocurrency?
Military finance offices might not be overwhelmed with those seeking information about crypto, but the issue is important enough that the Internal Revenue Service has a set of regulations defining cryptocurrency’s status, how it may be taxed, and what Americans need to do to properly report their investments in this area on their federal tax forms.
What follows is NOT tax advice. It IS reporting on the materials published and distributed by the Internal Revenue Service.
Tax laws are subject to frequent change and for the most current tax year’s laws in any area (but especially crypto) you will need to consult a tax professional. Never assume that what you read online is the most current guidance until doing so.
What The IRS Says About Cryptocurrency
Let’s start by defining terms. The Internal Revenue Service refers to Bitcoin, Dogecoin, Ethereum, and others as “virtual currency”. If you search the IRS official site for policy related to crypto, search using “virtual currency” for best results.
What is the IRS idea of a virtual currency? From IRS.gov, which views Bitcoin and the rest specifically as a type of currency, “that utilizes cryptography to validate and secure transactions” digitally recorded on a “distributed ledger, such as a blockchain.”
There’s more. The IRS says virtual currency is a “digital representation of value” serving as a “medium of exchange, a unit of account, and/or a store of value.” It may act like fiat currency or actual cash.
In the eyes of the IRS, virtual currency does not have legal tender status in America. It is a “convertible” currency.
Tax Liabilities For Bitcoin?
The sale, exchange, or trade of virtual currencies may result in a tax liability. There is also potential tax liability for using virtual currency to pay for goods or services. You can also be taxed for “holding virtual currencies as an investment”.
Since virtual currency is treated as property on your federal tax forms, the rules that apply to property also apply to Bitcoin and others like it where applicable.
The IRS has stated on some forms and publications that in certain respects only specifically named virtual currencies may be subject to certain types of taxation. Ask a tax professional for further clarification.
For the purposes of this article, all virtual currencies are addressed but you’ll need to get professional tax advice to learn whether those rules apply specifically to your circumstances.
A payment made using virtual currency must be reported to the IRS in the same way you report other property. The following rules may apply:
- When making payments to independent contractors and other service providers that are taxable, self-employment tax rules generally apply even when paying via virtual currency.
- Wages paid to employees using virtual currency are taxable and must be reported by an employer on a Form W-2. These, the IRS says, are subject to federal income tax withholding and payroll taxes.
- Third parties who pay in virtual currency “on behalf of merchants that accept virtual currency” must report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions according to the IRS official site.
- Gains or losses from the sale or exchange of virtual currency depends on “whether the virtual currency is a capital asset in the hands of the taxpayer”.
Virtual Currency As A Capital Asset
The Internal Revenue Service has instructions for those who hold cryptocurrency as a capital asset. As mentioned above, the IRS does not recognize Bitcoin and others as currency, but rather as property.
That means that the taxation of Ethereum in this context has to do with its disposition as property, whether there was a profit or loss, and other variables.
The IRS says you could be taxed when you do any of the following with cryptocurrency or any other property. Some of what is listed below is not necessarily applicable to crypto but these are included here for context of the broader rules about disposing of property. You may have a tax liability when:
- You sell property
- You exchange property for other property
- Your property is condemned or disposed of under threat of condemnation
- Your property is repossessed
- You abandon property
- You give property away
- You encounter a gain or loss when doing any of the above
How Much Is Virtual Currency Really Worth?
Virtual currency such as Bitcoin, Ethereum, etc. have no fixed market value. Unless you are dealing with so-called Stablecoins, which are backed by a specific amount of fiat currency (actual cash), the value of your virtual currency may fluctuate daily or even hourly.
How does the IRS calculate the fair market value of these assets?
IRS.gov states, “For U.S. tax purposes, transactions using virtual currency must be reported in U.S. dollars. Therefore, 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.”
That illustrates one of the inherent risks of virtual currency–the amount you are taxed upon might not be the actual cash value of your crypto at tax filing time. Whether that means a profit for the taxpayer or a loss depends on circumstances. It’s a risk worth contemplating.
Consequences For Not Reporting Virtual Currency To The IRS
The Internal Revenue Service official site lists multiple possible penalties for failing to report cryptocurrency on your federal taxes.
The first of these consequences? You may be subject to an audit. The results of such an audit could, depending on circumstances, include monetary penalties as well as any interest associated with them.
“In more extreme situations” the IRS warns, you may be prosecuted for “failing to properly report the income tax consequences of virtual currency transactions”. If you are prosecuted in this manner you could be charged with tax evasion and filing a false tax return. Such charges may result in prison time and fines that go as high as a quarter of a million dollars.
Always discuss all your holdings with a tax professional if you aren’t sure about the current year’s tax laws, your specific obligation for reporting such assets, and the consequences of overlooking or omitting them from your tax filings altogether.
Using a tax professional to file your taxes is strongly encouraged when you have issues more complicated than a standard tax filing. The money you spend on tax prep today may be the IRS audit you avoid tomorrow. That’s not meant to serve as a promise you won’t get audited anyway, but the more seriously you take such taxation issues, the better off you are.
Joe Wallace is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News