Tax Planning for U.S. Bitcoin Investors
Tax Planning For U.S. Bitcoin Investors
The use of Bitcoin and other virtual currencies is on the rise. Exactly how many users and investors there are in the U.S. is hard to say.
Coinbase, which is a digital currency marketplace here in the U.S., has claimed in excess of 10 million clients. Strangely enough, the IRS stats say only about 800 people per year file Form 8949, Sales and Other Dispositions of Capital Assets, to report their transactions with bitcoin or other virtual currency.
As a result of such discrepancies, The Tax Advisor reports that the IRS has required Coinbase to disclose account records for over 14,000 clients with transactions in bitcoin of more than $20,000 annually. (Coinbase Inc No. 3:17cv01431(N.D. Cal. 11/28/17)).
This information is not about dealing with typical law-abiding, taxpaying American citizens.
- The information will be used by the IRS to find evidence about money laundering or the concealing of income as tax fraud and other types of federal crimes.
- The IRS now has software so they can identify owners of the digital wallets that are used to store the bitcoins, so they can track the source of the transactions.
Guidance from the IRS
In 2014, theIRS released Notice 2014-21, fully 5 years after Bitcoin was being sold to the public. This was the first set of guidelines to outline the federal income tax treatments for virtual currencies. Bitcoin is used as an example of a virtual currency that can be converted when it is digitally traded, purchased or exchanged for U.S. dollars, or other types of virtual currency.
- Virtual currency is considered property for your federal taxes, so all of the general tax principles apply as they would to other property transactions.
- Notice 2014-21 does not consider virtual currency to be a currency that would have an exchange rate, and make a Section 988 foreign currency loos or gain.
- Before the Tax Cuts and Jobs Act in 2017, some considered the exchange of a virtual currency for another form of currency to be a Section 1031 like-kind, tax deferred exchange.
- The TCJA changed Section 1031 so property that is eligible as like-kind treatments is now limited as “real” property. This put a stop to the tax deferral for virtual currency investors.
Professional Miners, Traders and Business in the Virtual Currency Industry
Bitcoin miners, traders or other professionals who are involved with virtual currency as a business are dealt with differently than individuals in Notice 2014-21. The Notice deals with 3 different uses for the virtual currencies.
Investment as a Capital Asset
- If virtual currency is spent to purchase other property, which includes other types of virtual currency, a gain is recognized between FMV (fair market value) of what was purchased and the adjusted basis of the currency.
- If virtual currency has been held as capital assets, like stocks or bonds, the gain or loss is taxed like a capital gain or loss.
- If virtual currency has not been held as capital assets, like inventory or property held to sell to clients as part of a business, an ordinary gain or loss is realized on any exchange.
- If virtual currency has been treated as capital assets, net investment income tax applies to any change in the value while it was being held, even though this is not addressed in Notice 2014-21.
Virtual Currency Spent on Goods and Services
- Gross income must include the FMV, in U.S. dollars, of any virtual currency spent in exchange for any goods or services.
- Paying with virtual currency does not change any withholding requirements or information reporting.
- If wages are paid using virtual currency, the FMV is subject to the same payroll withholding and reporting on Form W-2, Wage and Tax Statement.
- Independent contractors paid more than $600 in virtual currency, must have it reported as a payee on Form 1099.
Wages for Working in the Virtual Currency Industry
- Taxpayers who receive bitcoin for using their computer resources for the validation of bitcoin transactions ow who maintain the bitcoin public ledger are subject to .income taxes.
- When the taxpayer is not an employee, if they work in the virtual currency industry, the FMV of any virtual currency earned is considered gross income. Net earnings are then subject to self-employment taxes.
As an individual taxpayer and personal investor, you are required to report your virtual currency transactions on Form 8949. You may find you do not receive the Form 1099 or a W-2 after your bitcoin or other virtual currency transactions from the other party. Unfortunately, that doesn’t matter, and you are still responsible to report in a timely fashion, or face penalties or interest. There is some possibility of penalties being reduced or reversed if you can give reasonable cause for your lack of reporting.
Issues Not Yet Addressed by the IRS on Taxes for Personal Investors in Bitcoin
The IRS has been unwilling to make any further comment to requests for additional information about how personal investors in Bitcoin are impacted. They simply refer back to the original Notice 2014-21, as if that explains everything.
The Tax Adviser is reporting that this list is what that original notice does not cover:
How to Report FBAR
The IRS has not issued any official guidelines for how to report Foreign Bank and Financial Accounts and filing FinCEN Form 114. If the value of virtual currencies held offshore, plus other foreign account balances, exceed $10,000 in total at any point in the year, they could be subject to the need for FBAR reporting.
The Adjusted Basis
When you purchase something with your virtual currency it is treated like it is 2 separate transactions.
- The disposal of your virtual currency.
- The spending of the equivalent dollar amount.
This means that every time you make a purchase with your virtual currency you will need to calculate the gain or loss. This gain or loss is treated like the exchange or sale of securities. It is easier with securities since the holding period and both the purchase and sale price are clear.
- The Notice 2014-21 does refer to the IRS Publication 551. The Basis of Assets is used to compute the basis, but this provides no insight about whether the virtual currencies are securities, commodities, or some other property type.
- Later on, in September of 2015, the CFTC did classify Bitcoin as a commodity. Other virtual currencies are still undefined.
- Sales of Bitcoins can be difficult to classify since the inventory is hard to measure. A FIFO system is most commonly used, but it depends on who is managing the wallet. Third parties may manage the wallets differently than the taxpayer might manage their own.
- Coinbase is the third party exchange managing accounts for many bitcoin holders. They have created an issue associated with the spinoff currency called Bitcoin Cash. They did not distribute this Bitcoin Cash to client accounts until December of 2017. Since the cash was created in August 2017 the question was raised about the value based on the date it was made, or the date that it was later distributed. Plus, some owners did not claim their split coins so they never did take ownership of their property. With all of this, plus the price fluctuations, if and when the Bitcoin Cash was received makes a big difference when it comes to the tax implications.
In 2018, 19 different states plus Washington, DC have virtual currency or specific blockchain legislation. This covers tax policies, plus they are forming task forces. They apply sales and use taxes as well. The states are not issuing income tax guidance, yet.
What Tax Preparers Need to Do
Many questions about both federal and state taxes have yet to be addressed when it comes to Bitcoin and other virtual currencies. The IRS is pursuing account holders quite aggressively, so accountants must be proactive in the identification of situations where reporting will be necessary. With the FBAR penalties it looks like personal investors in Bitcoin need to carefully watch for when foreign virtual currency plus other foreign accounts reach the FBAR threshold amounts.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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