As a holder of virtual currency like Bitcoin or Ether, you may have questions about how this currency affects your taxes. How does the IRS treat virtual currency? Is it taxable? If you have virtual currency, do you have to report it? Simply put, the IRS can and does tax virtual currency transactions, just like it taxes any other property or currency.
Let’s dive deeper into which types of virtual currency transactions are taxable or not taxable and the IRS rules for reporting virtual currency exchanges.
Which virtual currency transactions are taxable?
1. You receive virtual currency as a payment for goods and services.
Taxable. The virtual currency you receive is taxable as either ordinary income or a capital gain, based on certain facts and circumstances.
2. You exchange virtual currency for other property.
Taxable. The virtual currency is a taxable gain or loss depending on the fair value of the property you received and the tax basis of your currency.
3. You receive virtual currency because you’ve successfully mined it.
Taxable. The currency you’ve mined is taxable as ordinary income. It may be subject to the self-employment tax.
4. You sell your virtual currency for real currency.
Taxable. This exchange is taxable as a capital gain or loss.
5. You receive virtual currency from an employer as payment for your work.
Taxable. The virtual currency you receive is taxable as wages. It’s subject to payroll taxes, the same as real currency.
6. You pay for services using virtual currency.
Taxable. This is a taxable exchange of property for services, which may result in a capital gain or loss.
7. You exchange property that’s not U.S. dollars for virtual currency.
Taxable. This exchange could be a taxable gain or loss.
8. You have cryptocurrency that experiences a hard fork, but you don’t receive any new cryptocurrency.
Nontaxable. Since you didn’t receive any new cryptocurrency, no taxable event occurred.
9. You have cryptocurrency that experiences a hard fork, and you receive new cryptocurrency.
Taxable. The new cryptocurrency is considered taxable income in the year you receive it.
10. You receive virtual currency as a bona fide gift.
Nontaxable. As the recipient, the currency isn’t taxable unless you sell or exchange it later. But, if you’re the donor of the currency, you may be subject to the gift tax.
11. You donate virtual currency to a charity.
Nontaxable. But, you may be able to claim a charitable contribution deduction.
12. You own multiple digital wallets and transfer virtual currency from one wallet to another.
Nontaxable. You’re just transferring your own currency!
Reporting virtual currency to the IRS
As a holder of virtual currency, you need to know how and when to report transactions with the IRS. Here are some key reporting requirements you’ll want to keep in mind.
1. You pay wages to employees using virtual currency.
You’re required to follow payroll reporting requirements, which include filing Forms W-2, 940, and 941 and various other state and local reports.
2. You pay $600 or more to a vendor in connection to your trade or business.
You should evaluate this transaction as it may be subject to Form 1099 reporting requirements.
3. You invest in cryptocurrency – performing buy and sell transactions during a tax year.
There’s no need to report purchases of cryptocurrency, though you should maintain those records. You must report sales of cryptocurrency on Form 1040, Schedule D.
4. You own an account or wallet that’s held by a foreign virtual currency exchange.
Currently, the IRS has no reporting requirements for this scenario. But, they’re evaluating the need for taxpayers to report this on Form 8938 or if it should be subject to Foreign Bank Account Reporting (FBAR) rules.
You may want to consider proactively reporting your digital wallets held by a foreign exchange as the IRS increases its scrutiny in this area.
5. You make a bona fide gift to another individual using virtual currency.
As the donor, you may have to file Form 709 if the value of the gift is more than $15,000 in 2019.
Don’t let airdrops surprise you
Airdrops are taxable events that you could easily overlook. If you own any digital currencies, you should carefully review your transaction history to determine if you received new coins via airdrop during the current year and past years.
Have you received airdrops and forgotten to report them on your individual tax return for the appropriate tax year? You should consider amending your return(s).
Bitcoin experienced three hard forks between 2017 and 2018 alone, so Bitcoin holders, in particular, should take a closer look at their airdrop history and tax returns for those years.
Why should you care about all this?
The IRS is paying attention to virtual currency and has made virtual currency compliance an area of focus. In 2018, the IRS announced an audit campaign targeting taxpayers who may not be complying with tax laws.
And, the agency issued letters (here’s a sample) to taxpayers it believes are willfully noncompliant, negligently noncompliant, or may have misreported one or more virtual currency transactions.
The IRS states, “Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties, and interest. In some cases, taxpayers could be subject to criminal prosecution.”
It’s best to be proactive about reporting your virtual currency and complying with IRS requirements.
Virtual currency: a digital representation of value that functions like a country’s traditional currency. Examples of virtual currency include Bitcoin, Ether, Roblox, and V-bucks.
Convertible virtual currency: virtual currencies that can be digitally traded and converted into a real currency like U.S. dollars.
Cryptocurrency: a type of virtual currency that uses cryptography to encrypt transactions that are digitally recorded on a distributed ledger.
Digital wallet: a software program that stores private and public keys and interacts with various types of cryptocurrency. It enables users to send and receive digital currency and monitor their balance. It’s basically an online account for your virtual currency.
Hard fork: a permanent change in one type of cryptocurrency that leads to a new cryptocurrency without replacing the old one.
Airdrop: an event where coins are electronically delivered to a group of investors. Airdrops usually occur after a hard fork – the new currency is delivered to holders of the pre-existing currency. Airdrops may also occur whenever a brand new currency is formed. They often happen unannounced.
If you hold virtual currency and need help with your tax reporting or have received a letter from the IRS, let’s talk about your options!
