Understanding Bitcoin and Taxes
As cryptocurrencies like Bitcoin become more mainstream, the Internal Revenue Service is paying close attention. In fact, from the close of 2018 and onward, we’re looking at monumental changes in how the IRS is considering these technologies, at least financially.
The IRS currently considers cryptocurrency to be property. But that doesn’t mean one should avoid reporting gains. The agency has always been more lenient on taxpayers and investors who jump the gun in this regard. Coming forward sooner rather than later can help prevent stricter penalties or fines because of non-reporting.
Recently, the agency released a friendly “reminder” that taxpayers must report all income from virtual currency transactions when filing federal tax returns. Transactions and profits from digital currencies are taxable by law, like “any other property” owned. If anything, this shows the IRS is planning to ramp up their focus on crypto and virtual earnings.
What happens if you don’t listen?
Failing to report income from virtual currency can lead to audits, as well as penalties on non-payments, including interest. The agency also states that in “extreme situations,” those affected can face “criminal prosecution,” including charges for tax evasion and filing a false tax return. If convicted, one may be subject to a fine of up to $250,000 and a sentence of five years in prison. Yikes.
It’s no surprise the IRS is issuing reminders. Currently, U.S. households are estimated to owe about $25 billion in capital gains due to digital currency holdings — and almost no one is paying. So, it’s safe to say at some point soon, the IRS is going to get serious about collecting taxes for virtual currencies.
When they do finally put their foot down, it’s not a good idea to get caught up in the crossfire. If you haven’t already, you should make tax reporting of your virtual currency gains and income a primary focus.
Bitcoin and Taxes: To File or Not to File
The first thing to address is how Bitcoin and crypto get taxed. As expressly outlined by the IRS, Bitcoin and taxes considerations include:
- Payments in virtual currency are identical to payments made using any other property.
- Payments made to independent contractors and service providers with virtual currency are taxable.
- Earnings from virtual currency for services rendered are subject to self-employment tax.
- Wages paid to employees through virtual currency are taxable to the employee and must be reported on a W-2. They are also eligible for tax withholding and payroll taxes.
- Third-party settlements made in virtual currency on behalf of merchants are also taxable and must be reported on 1099-K forms.
- Trading, exchanging, receiving payments, converting to fiat and spending virtual currency are all taxable.
- Even Bitcoin or virtual currency miners must report their receipt gains as income.
More importantly, “the character gain or loss” stemming from the exchange of virtual currency hinges on whether or not it is a “capital asset” in the hands of the taxpayer. Let’s say someone buys a single Bitcoin for $200. Later, they take that coin — now valued higher — and use it to buy a $400 gift card. At the time of the original acquisition it was worth $200, so that means there is a $200 taxable gain. Whether or not this is a short- or long-term capital gain depends on the holding period of time they owned that particular coin. They’re also subject to different rates.
The IRS considers virtual currencies to be very much the same as all other forms of currency when it comes to taxation, including fiat monies.
How to Report Taxes for Virtual Currency
Luckily, common reporting software like TurboTax and H&R Block make it easy for users to report virtual currency income on their taxes. To file without such tools, one must use the Schedule D form for capital gains, as well as any other related forms for how currencies are handled. To report employee earnings, for example, one must fill out a W-2.
As far as when to file, that can take place at the end of the year, the same as handling income or federal taxes. The only exception is when self-employment tax is involved. In that case, it may be more beneficial to file quarterly taxes based on previous filings.
All information related to virtual currency tax reporting comes straight from the agency. If you need to know more about Bitcoin and taxes, you can always turn to the IRS.
Kayla writes about cryptocurrency, blockchain and technology in general. Her work has been featured on The Week, The Daily Dot, Cointelegraph and Bitcoin Magazine. To read more posts by Kayla, please visit her blog: https://productivitybytes.com.