Cryptocurrency Tax Laws
Cryptocurrency Tax Laws: In the past five (5) years, cryptocurrency has taken center stage with the IRS. Even with the issuance of Revenue Rule 2019-24 and Notice 2014-21, there are still many unanswered questions about cryptocurrency and Bitcoin (terms used interchangeably in this article) – especially in the offshore & international Cryptocurrency arenas.
In recent years, we have seen the:
- introduction of J-5,
- IRS vigorously pursuing the Coinbase Summons, and
- the issuance of 6173 and 6174 notices
As a result, Taxpayers with cryptocurrency must be cognizant of the basic tax rules.
We will summarize the basics of U.S. cryptocurrency tax laws.
Increased IRS Cryptocurrency Tax Law Enforcement
Cryptocurrency tax law has taken over where Swiss banking left off.
While today, cryptocurrency is a respected (and lucrative) investment vehicle, the Internal Revenue Service still associates cryptocurrency with Silk Road and the Dark Web.
The IRS seeks to recover the estimated billions of dollars of unaccounted tax dollars resulting from Taxpayers not properly complying with cryptocurrency tax rules — and they are ramping up enforcement.
To date, the IRS has not provided definitive guidance on all the issues involving cryptocurrency and US tax law.
But in the past few years, the Service has provided some additional clarifications to assist people with getting into tax compliance.
This article is by no means a complete guide to all things cryptocurrency. It is starting point for those of you who may have sold or exchanged cryptocurrency (or are thinking about it), invested in cryptocurrency funds, or just watched your investments skyrocket and are now considering selling.
Rev Ruling 2019-24 (Gross Income)
Revenue Ruling 2019– 24 provides some clarifications involving how cryptocurrency is taxed.
The ruling presented two main issues:
- If a person owns cryptocurrency, and then a hard fork occurs (similar to a US stock split), is there taxable income?
- What about if a person receives airdrops in accordance with the hard fork?
While the ruling is very long, the general finding is that a plain hard fork would not result in taxable income, since the hard fork did not result in a taxable event.
But, if the taxpayer also receives airdrops of new cryptocurrency in accordance with the hard fork, then something was gained (airdrops) and therefore the airdrops are taxable income.
Cryptocurrency Tax FAQ
Here are some of the basics of Cryptocurrency tax law:
Cryptocurrency Tax on Property Exchange (Example)
Let’s say you wanted an asset that your friend Michael owns and it has a FMV of $10,000.
Your cryptocurrency is worth $8,500 and you paid $8,500 for it, but Michael really wants your cryptocurrency, because after reading a Wired article, newbie Michael is convinced your cryptopcurrency is going to skyrocket in value.
Therefore, you exchange your $8,500 crypto, for his $10,000 asset.
From the IRS’s perspective you “received” and asset worth $10,000, but you only “put up” $8,500.
Therefore, the property in your hand now is worth $10,000 (FMV on that date) — and you made $1,500.
This is not a “gift” so the carryover basis rules do not apply.
And, even though no money was exchanged, you are taxed on the $1,500 gain. If you sell it down the line, the basis will then be $10,000.
This is important, especially as the income values increase, because you want to make sure you have some liquidity when tax-man (or woman) comes knocking.
You Received Cryptocurrency as Income
If you receive cryptocurrency as income, that crypto is reportable as ordinary income, and taxed as income.
For example, if you are a consultant and one of your clients paid you for services in cryptocurrency, then that income is taxed as self-employment income on your tax return.
On the flip-side, the employer would deduct the expenses of paying you just as if the employer was deducting other forms of payment for services rendered.
The employer would not deduct it as a “sale” but rather as an expense.
Mining & Cryptocurrency Tax Laws
Mining for cryptocurrency is sorta, kinda similar to mining for gold.
With mining for cryptocurrency, it is oftentimes done with the hopes of receiving a reward for the work performed and verifications completed – but a payout is not guaranteed.
How the tax rules will apply for income generated from mining is impacted by the character of the performance.
In other words, is the person doing the as a business or trade, or if it is just a hobby.
With hobbies, there are some losses that maybe taken, but oftentimes they’re limited due to the fact that they’re not being conducted for business, per se.
Capital Gains (or Losses) & Cryptocurrency Tax Law
Oftentimes, the income generated from cryptocurrency will come as a result of capital gains.
For example, Jennifer purchased cryptocurrency worth $80,000, which is now worth $600,000.
She wants to sell the cryptocurrency for fair market value, but wants to know how she’s going to be taxed.
The capital gain sale of crypto is equivalent to any other asset sale.
In other words, if Jennifer’s adjusted basis is $80,000, and she sells the cryptocurrency for $600,000, and she has $520,000 of gain.
If the gain is short-term gain, she’ll be taxed at her progressive tax rate, and if the gain is long-term capital gain, she will be taxed at either 15% or 20%.
Dividends or Interest
If your cryptocurrency is pooled in a fund that generated interest, dividends or capital gains, it is taxed according to its character.
Practice tip: If your pooled cryptocurrency fund is in a foreign fund, beware of potential PFIC tax treatment.
Soft Forks, What are Those?
This is generally just a change in software-related/technical issues, and not normally a taxable event.
About 1-2 years ago, the IRS stated it would not be developing a “stand-alone” cryptocurrency voluntary disclosure program.
If you are out of compliance, you should consider domestic or offshore voluntary disclosure.