When tax season approaches, Americans prepare to make payments and file returns. It is also time to begin work on keeping new records for the next fiscal year. Participants who have traded in cryptocurrencies such as bitcoins are concerned about all of the changes.
The Internal Revenue Service (IRS) ordered the Coinbase cryptocurrency exchange in 2017 to turn over any data pertaining to transactions done by more than 14,000 of its clients who purchased, traded, received, or transferred more than $20,000 in bitcoins (BTC) between 2013 and 2015. Those who predicted that Uncle Sam would investigate and impose the requisite taxes and penalties on bitcoin transactions were accurate. On July 26, 2019, the federal agency said that it would issue instructive letters to 10,000 individuals who it believes “failed to disclose income and pay the consequent tax from virtual currency transactions or did not record their transactions correctly.”
“Taxpayers should take these letters very seriously by evaluating their tax files and, if necessary, amending old returns and paying back taxes, interest, and penalties,” IRS Commissioner Chuck Rettig stated in a news statement. “The IRS is boosting its virtual currency activities, including a greater use of data analytics. We are committed to upholding the law and assisting taxpayers in properly understanding and meeting their duties.”
Though these events may have surprised some cryptocurrency supporters, it is critical to recognize that taxes are on the horizon, regardless of the form of transactions or asset classes.
Let’s take a look at a few key points to remember while drafting tax returns for cryptocurrency buyers and sellers.
Bitcoin Record-Keeping Is Your Responsibility
Cryptocurrency trading is available via hundreds of brokers, middlemen, and exchanges. None, however, are required to furnish tax reports to market participants, but some may do so at their discretion. Coinbase, for example, does publish a “cost basis for taxes” report.
Finally, the person is accountable for keeping all relevant documents about their bitcoin transactions.
Say you acquired ten bitcoins for $3,000 each six months ago or got them as payment for work you completed for a customer. These bitcoins may be worth $9,000 apiece today, putting your potential profit at $6,000 per coin.
It is your job to keep the relevant paperwork proving that you got them when they were worth $3,000, and so your net revenue per coin is $6,000 Failure to save such transaction data and paperwork may result in your assets being assessed at $9,000 apiece, greatly raising your tax burden.
Any bitcoin transaction may be taxed. Assume you received five bitcoins five years ago, spent one at a coffee shop four years ago, two more through an internet portal three years ago, and sold the other two for the corresponding cash amount one month ago. You are supposed to keep track of the dollar equivalent value of each such transaction on the different dates and determine your net dollar revenue from bitcoins. Your tax burden will be calculated as a result.
Understanding Bitcoin Taxation
To keep accurate records, it is necessary to understand how different cryptocoin transactions are taxed. Depending on the kind of bitcoin transaction, the following possibilities should be considered for tax purposes:
If bitcoins are received as payment for products or services, the holding time is irrelevant. They are taxed and must be reported as regular income at the fair market value on the transaction date. The federal tax rate on such income might vary from 10% to 37%. In addition, there may be state income taxes to pay.
Bitcoins obtained via mining activities are considered as regular income. In addition, such revenues may be subject to a self-employment tax.
Cryptocoins obtained during a hard fork exercise are not taxed as regular income, but those obtained through other actions, like as an airdrop, are.
If bitcoins are purchased as an investment and then sold for a profit, the status of such revenue is determined by the holding time. Net revenues are classified as regular income if kept for less than a year, and may be subject to extra state income tax. If the holding period exceeds a year, it is considered capital gains and may be subject to an extra 3.8% tax on net investment income.
Account for Bitcoin Tax Reductions
You may be able to minimize your tax obligation if you give your cryptocoins, such as bitcoin or ethereum, to approved organizations.
For example, in 2017, the Fidelity Charitable Fund received bitcoin gifts totaling around $69 million. The charity fund’s operating mechanism guarantees that the bitcoins received are instantly sold on the Coinbase market. The monetary amount obtained from such a transaction is invested according to the donor’s preference, who benefits from a tax deduction in the year of the contribution.
However, only cryptocoin contributions made to approved charities are eligible for such deductions. Selling the tokens and subsequently giving the proceeds will not lessen your bitcoin tax liability. Individuals who itemize their tax returns may also take advantage of the deductions.
Provisions for Cryptocurrency Losses
Cryptocurrency losses, like stock investment losses, may be used to offset capital gains, subject to certain limitations, and losses that are not used to offset gains can be deducted—up to $3,000—from other types of income. The guidelines also provide provisions for carrying forward losses.
Reporting Bitcoin Income
Bitcoin transactions should be recorded on Schedule D, which is an attachment to Form 1040. Depending on the kind of transaction that determines the type of income from cryptocurrency—ordinary income or capital gain—the revenue should be recorded in the relevant columns of the form under the appropriate heading.
The Bottom Line
Despite the fact that the IRS issued its initial set of guidelines and restrictions in 2014, less than 900 people reported capital gains or losses from Bitcoin trading between 2013 and 2015. As the IRS begins to tighten down on cryptocurrency taxes, it is critical for people to keep records of their transactions and to be prepared for any examination, tax payments, and any fines.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is very dangerous and speculative, and this article is not a suggestion by Investopedia or the author to do so. Because every person’s circumstance is different, a knowledgeable specialist should always be contacted before making any financial choices. Investopedia makes no guarantees or warranties about the accuracy or timeliness of the information provided on this site.
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