New IRS Guidance on the Taxation of Virtual Currency
Have you heard about virtual currency? As the IRS defines it, it’s “a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency.”
Virtual currency, which includes Bitcoin (BTC), Bitcoin Cash (BCH), Ethereum (ETH), and other cryptocurrency is widely used throughout the world. It is accepted by some major retailers and used as a form of payment for some employers, also. Others trade virtual currency for recreation and hold onto it as a capital asset.
The IRS recently clarified the tax treatment of virtual currency transactions and how they affect income tax. Learn more about the changes here.
New Rules on Virtual Currency Tax
The IRS has released new guidance for those who use virtual currency. The guidance educates taxpayers about their reporting obligations for virtual currency through Revenue Ruling 2019-24 and the frequently asked questions.
IRS and Virtual Currency: A Brief History
The IRS first published guidance on virtual currency in 2014, explaining that virtual currency is treated as a capital asset, as long as it can be converted into cash. Capital gains rules still apply to any gains or losses through virtual currency trading.
This still holds, but due to the surge in popularity of virtual currency, the IRS has expanded its tax guidance.
A Summary of New Cryptocurrency Tax Changes from the IRS
The IRS ruling focuses on basis and gain or loss on the sale of exchange of virtual currency. Basis is generally what you spent to acquire the virtual currency. Here are five takeaways to consider:
1 – Charitable Contribution Deductions
Taxpayers can contribute virtual currencies to charities and can get a charitable contribution tax deduction. Gain or loss isn’t recognized on the contribution of appreciated virtual currencies.
If the virtual currency is held for more than one year, the donation is equal to the fair market value of the currency at the time of the donation. However, if the virtual currency is held for less than a year, the deduction is the lesser of basis in the virtual currency or its fair market value at the time of the charitable contribution.
2 – Virtual Currency Transfers
The IRS previously advised that virtual currency is to be treated as a capital asset if converted to cash. So, capital gains rules apply to any gains or losses on the sale or transfer of virtual currency and should be reported on a Schedule D.
What is now clarified by the IRS is this: transfers of virtual currency from an address, wallet, or account that you own, to another you own, is a non-taxable event, even if you receive an information return for the transfer, such as Form 1099-K.
3 – Getting Paid with Virtual Currency
The IRS provided more information regarding virtual currency transactions in exchange for work performed. In that situation, virtual currency is taxed as ordinary income. So, if an independent contractor is paid with virtual currency for services performed, the compensation should be reported on Form 1099. The recipient must pay income and self-employment tax on the compensation. If an employer pays a traditional employee via virtual currency, it must be reported on Form W-2 in U.S. dollars. The wages are subject to federal income tax and social security tax withholding. Throughout the year, as well, the IRS suggests you keep good records of each payment (converted to dollar-based wages) at the date of receipt.
4 – Paying With Virtual Currency
The IRS also clarified paying for goods using virtual currency. This also comes down to capital gains and losses.
When a taxpayer makes a payment, they have a capital gain or loss. This is the difference between the fair market value of the goods received, and the adjusted basis in the virtual currency exchanged. Generally, basis is what the taxpayer paid to acquire the virtual currency.
5 – Forks
Hard Forks: The new IRS guidance also comes with some clarification about hard forks. A hard fork is a “protocol change” in “distributed ledger technology.” It may result in a new form of cryptocurrency, which may be “airdropped” to your wallet. If you can transfer, sell, exchange, or otherwise dispose of the new currency, you have “dominion” over the new currency and it is taxed as ordinary income. This ordinary income is equal to the fair market value in U.S. dollars of the new cryptocurrency when obtained. If you don’t have dominion over virtual currencies after a hard fork, you do not have taxable income.
Soft Forks: Soft forks occur when a distributed ledger undergoes a protocol change that does not result in a diversion of the ledger and thus does not result in the creation of a new cryptocurrency. Soft forks are not taxable because taxpayers are not getting new cryptocurrency.
Get more insight into virtual currency tax clarifications in the FAQs.
More Help With Cryptocurrency Tax
Taxpayers must have good tax record-keeping if they hold virtual currency, as the IRS is zeroing in on virtual currency compliance. This summer, the IRS issued multiple letters to taxpayers who may have failed to report or misreported transactions involving virtual currency, which could result in having to pay additional taxes, penalties, and interest. Some letters are just reminders and others require a response; those who do not respond with required information could face audits or further investigation.
Luckily, Block Advisors can help. With more than 15 years’ average of experience with a range of complex tax issues, our advisors have specialized knowledge for your unique tax situation. Find your advisor match.