Treasury Secretary Janet Yellen is not very good at bitcoin, a point she recently reiterated when she called the digital currency speculative and “inefficient.”
That doesn’t mean that Yellen and the department she heads, which includes the Internal Revenue Service, don’t care about cryptocurrency.
Now that it is income tax filing season, people who own bitcoins and other cryptocurrencies will find that the IRS is very curious about taxpayers’ cryptocurrency transactions.
So much so, that they have modified the first page of Form 1040, the main tax document that taxpayers file annually, to ask them if they have received, sold, sent, exchanged “or acquired in some other way.[d] any financial interest in any virtual currency? “
A ‘yes’ could mean more taxes, but not necessarily, tax experts told MarketWatch.
Cryptocurrencies continue to have a higher profile. Last week, bitcoin reached a market value in excess of $ 1 trillion. As more people search for cryptocurrencies, more people have to deal with the tax rules at play.
“It can be super, super easy or it can be incredibly complicated,” said Matt Metras of MDM Financial Services in Rochester, NY. Some transactions can stimulate multiple tax events at once, but tax professionals have little IRS guidance to work with, he said.
Here’s an introduction to some tax season issues when it comes to cryptocurrencies.
The basics of how the IRS views cryptocurrencies
The IRS treats cryptocurrency as property. It is helpful to remember the tax rules that also apply to stocks. If the value increases and the owner sells at a profit, he will likely pay capital gains taxes.
If the sale for profit occurs within a year, the proceeds count as a short-term capital gain. That is taxed as ordinary income, which means it is bundled with other things like wages and taxed in the group the taxpayer is in.
If the sale occurs at least one year after the acquisition, then it is a long-term capital gain. A single taxpayer earning less than $ 40,400 and a married couple earning less than $ 80,800 earn a 0% rate. Almost everyone else gets a 15% rate, and the rate applies to income up to $ 445,850 for individuals and $ 501,600 for married couples filing jointly.
It is still a lower rate than five of the seven income tax brackets.
But cryptocurrency is somewhat volatile. For example, shortly after the market value of bitcoin hit the $ 1 trillion mark, it approached a bear market.
So it’s important to remember the tax treatment of losses, said Ben Weiss, COO and co-founder of CoinFlip, which has bitcoin ATMs in 1,800 locations that allow people to buy and sell cryptocurrencies.
If the value goes down and the investor sells at a loss, they get a deduction for capital loss. When annual losses exceed annual earnings, the taxpayer can also deduct up to $ 3,000 / year. Excess losses beyond that can be carried over to future tax years.
What happens if I get paid in cryptocurrencies?
When you get paid for services through bitcoin BTCUSD,
or any other cryptocurrency that counts as ordinary income. It does not matter what the means of payment is when it comes to the question of “whether the compensation constitutes wages for employment tax purposes,” the IRS said.
The cryptocurrency an independent contractor receives for work counts as self-employment income, the IRS noted. In both cases, the value of the cryptocurrency is measured by its value in US dollars on the date of receipt.
So how do I answer this question from the IRS?
Near the top of the 1040, the IRS wants a ‘yes’ or ‘no’ to this question: “At any time during 2020, did you receive, sell, ship, exchange, or otherwise acquire any financial interest in any virtual currency? “
Remember, a ‘yes’ doesn’t necessarily mean more taxes, experts said. For example, if someone only buys and has crypto, there is no tax event because there is no resulting sale for a profit or loss, Metras said. Someone like that could mark ‘yes’ to the answer and not have to report the purchase on its return, he added.
Laura Walter, owner of Crypto Tax Girl outside Salt Lake City, Utah, says you should say ‘yes’ if, for example, you sold crypto, traded it, spent it on goods and services, received it as compensation, or received it. an airdrop or fork. (A hard fork can occur when a digital currency splits and an airdrop is a way for a business to promote a coin with a giveaway and ship it over the air to general ledger addresses.)
Parsing the language in the 1040 instructions, Walter says you can mark ‘no’ if you just held it, transferred it between your own digital wallets, and also if you just bought it but did nothing else.
“You don’t have to report anywhere how much you have or where. All you report is when you have a taxable event, ”he said.
Metras, however, believes that a person should answer “yes” if they simply bought cryptocurrencies.
“There are mixed messages coming out of [the IRS] who should check the box, ”Metras said. “I think the IRS and the Treasury are not sure what data they are trying to get out of the question. … I think the possible repercussions of unnecessarily checking ‘yes’ are much less than not checking ‘yes’ when the IRS decided it should have been. “
Where do I get my necessary tax records?
Brokerage firms will automatically generate the necessary tax paperwork, but that’s not necessarily the case on cryptocurrency exchanges.
The task of counting profits and losses may fall to the holder of the cryptocurrency, Walter said. “My biggest tip for taxpayers is to keep track of your records.” Tax software can track transactions, he said. Another way is a simple spreadsheet, Weiss said.
People who haven’t been keeping a close eye on it all year, “basically everyone that I work with, Walter said, can go back and collect transaction information from their wallets and the exchanges they have used. But that takes time.
For beginners who got into crypto and are sorting out their trades, buys, and sales, Walter has another tip: “Just file an extension. You can’t do this overnight ”before an appointment with a tax preparer.
Exchanges like Gemini, Coinbase and Kraken have to keep transaction records for five years, Weiss said. Don’t be afraid to contact them if you have questions, he said. “It’s better to talk to customer service and be ashamed of not knowing your password than not having those records,” he said.
What are my audit risks?
They could be getting more serious.
IRS officials could soon “move from education to compliance and enforcement,” according to Metras. Still, he added later, “we don’t know exactly what the execution phase will be like.”
Giving the virtual currency issue such a prominent play in 1040 is a good indicator that IRS officials are “keeping an eye on” cryptocurrency, Walter added.
Others also think the IRS is getting serious. “Regulators are prepared to initiate a series of enforcement actions related to virtual currency tax fraud,” wrote attorneys at BakerHostetler, a national law firm.
In the summer of 2019, the IRS sent more than 10,000 letters to virtual currency holders that possibly did not report all income and tax obligations. The “educational letters” were part of the IRS’s growing focus on cryptocurrency, IRS Commissioner Charles Rettig said at the time.
The IRS probably didn’t have its sights set on taxpayers with smaller stakes, MarketWatch tax columnist Bill Bischoff said at the time. “The agency is more interested in tracking individuals and businesses that engage in significant virtual currency transactions without complying with tax rules,” he said.
A little bit of fiscal common sense can go a long way. “If you sell $ 50,000 of bitcoin and a wire transfer is shown for that amount, they’ll see it,” Weiss said. “Basically, you’re rolling the dice if you put $ 50,000 in the bank and don’t report anything.”