Tax Tips for Cryptocurrency U.S. Investors
For those that don’t know what cryptocurrency is, it is a form of digital currency where transactions occur on a blockchain technology. It is a peer-to-peer network that is both digital and decentralized. The currency can be stored on computers, smartphones, digital wallets and digital accounts. These accounts also allow holders to buy, store or trade the cryptos for either other types of cryptocurrency, tokens or fiat currencies.
Most jurisdictions, including the United States do not yet give crypto legal tender status, but that may be changing. Crypto seems to be a significant player in the investment marketplace and is causing countries around the world to question their regulatory status and try to race to build a framework that both regulates and answers all of the legal questions that have popped up. In fact the IRS has had to invest some serious resources quickly to combat the rampant tax non-compliance for those who have invested in crypto and failed to pay taxes on the earnings.
Right now there are over 1,664 different cryptocurrencies with new ones being introduced almost daily. The underlying rules of the network might change and cause a “fork” in the cryptocurrency that causes a split and makes it so the owner may actually own two different crypto currencies like bitcoin cash, and bitcoin. There are derivatives like bitcoin futures, and you can bet we are only seeing the beginning and it’s already become a complex system that has left a lot of unanswered questions for those who are trying to regulate it. At , there was a great article that tried to break down the issues and answer some of the questions.
The IRS issued Notice 2014-21 to try and apply some general tax principles to crypto. Some of the main points that came from that notice are:
- Cryptos have “an equivalent value in real currency or act as a substitute for real currency”
- IRS doesn’t view cryptos as generating foreign gain or losses for a U.S. tax return
- Cryptos are treated as property (like stock, inventory, or personal property)
- Taxpayers that receive cryptos in exchange for services or goods must include it’s fair market value at the time it was received in gross income
- Exchange rate is established by market supply and demand
- 1099 independent contractors are subject to self-employment tax if they receive cryptos for performing services
- Cost basis is determined by fair market value in U.S. dollars on the date received
- Record keeping should incorporate specific identification, first-in, first-out (FIFO) and the average-cost method can all be used to keep track of basis for tax reporting purposes
- It remains unclear how to treat crypto forks for tax purposes. If it forks is it considered income? It’s income if it’s not a gift and has measurable value. How about the timing of income recognition? It’s assumed it depends whether or not the holder of the pre-fork crypto exercises control and dominion over the post-fork crypto (crypto forks are only becoming more common which is making IRS guidance a more urgent necessity on how to proceed)
- FinCEN Form 114 says that cryptos that are held on an exchange that is foreign-based may be subject to reporting requirements. These foreign exchanges exhibit characteristics that are similar to foreign financial institutions and have custody of the users’ crypto.
Then the IRS issued a statement in 2014 that said:
The Financial Crimes Enforcement Network [FinCEN], which issues regulatory guidance pertaining to Reports of Foreign Bank and Financial Accounts (FBARs), is not requiring that digital (or virtual) currency accounts be reported on an FBAR at this time but may consider requiring such accounts to be reported in the future. No additional guidance is available at this time. [Erb, “IRS Says Bitcoin Not Reportable on FBAR (for Now),” Forbes (June 30, 2014), available at tinyurl.com/yav9z88v]
Regardless of what it says above, we suggest you err on the side of caution and report any foreign exchange accounts. Getting stuck with a huge bill and penalties that you aren’t prepared to pay is no walk in the park. Unless the IRS comes out with specific guidelines that indicate otherwise-report it. Save yourself the trouble.
The IRS has a dedicated task force that spends their days sniffing out tax fraud from crypto currency. So all of the money launderers out there that have been using blockchain technology to launder money should be on notice. The IRS considers virtual currency as a taxable asset and added it to their list of compliance campaigns. One of the largest exchanges out there, Coinbase has already provided the IRS user data that includes social security number, name, account activity and date of birth. It’s only a matter of time before the IRS will issue summonses to other exchanges besides just Coinbase. If you are caught not complying, there are civil penalties that include:
- Failure to file a tax return under Sec. 6651(a)(2): 0.5% per month of the unpaid tax, up to 25%.
- Failure to file Form 8938: Base penalty of $10,000 per failure to report an applicable asset, with an additional $10,000 for each month the failure continues, beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000.
- Failure to file FBAR: Base penalty of $10,000 per failure to report an account per year; increasing, if the failure is willful, to the greater of $100,000 or 50% of the total balance of the foreign financial account per violation.
- Accuracy-related penalty under Sec. 6662: 20% or 40%.
- Failure to file a tax return under Sec. 6651(a)(1): 5% of the unpaid tax per month, up to 25%
- Civil fraud penalties under Sec. 6651(f) or 6663: 75% of the unpaid tax.
If you haven’t filed your taxes for your crypto holdings, you may want to reconsider your course of action because the above list doesn’t even include criminal charges for tax evasion or whatever other crimes you can be charged with.
The IRS wants to help tax payers play ball and welcome any noncompliance individuals to come forward voluntarily and disclose their noncompliance. They have tried to streamline their procedures for compliance. They are trying to offer fairly easy processes to file delinquent or amended tax returns to fix the error of non-disclosure and resolve any outstanding penalty or tax obligations. This is only available to those that did fail to report their foreign income as a result of willful conduct. It’s probably the only time the IRS will allow an individual to claim ignorance to the law. If failure to comply is deemed criminal or results in huge penalties, then the streamlined compliance procedure is not an option for the taxpayer in question. It should be noted that voluntary disclosure does not necessarily grant immunity from prosecution, but it may result in the IRS being more sympathetic and not recommending prosecution. Also, you’ll still be stuck with the penalty. Unless you could sway the IRS that there was a good reason for your non-disclosure (which is unlikely, and ignorance isn’t a good reason).
Obviously what is best for each and every taxpayer will vary by each person’s situation and personal circumstances. It’s probably a safer route to voluntarily disclose and fix the non-compliance rather than waiting to be caught red-handed. Clearly we need more guidance from the IRS on cryptocurrency and all of the issues that surround the digital currency world, and it’s certain that such guidance will be coming. After all, the IRS wants their piece of the pie. Cryptocurrency is still new and growing and evolving quickly. You can rest assured that the powers that be will figure out how to regulate it and make sure individuals are compliant.
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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