As the initial surprise over the sudden emergence of virtual currencies winds down and Bitcoin is looking at its 10th birthday in the rearview mirror, we stop to take a look at the early history of cryptocurrency tax reporting. In this article, we will explore the beginnings of cryptocurrency reporting on Form 1040 and various other foreign information reporting forms along with the first IRS guidance issued on the topic. For more information on the latest updates visit my new article Tax Perspective for the Virtual Currency Enthusiast.
Only a few short years ago, investors were attempting to figure out whether cryptocurrencies presented a once-in-a-lifetime opportunity or the next bubble to burst akin to the dot-com craze of the late 1990s. The ever growing number of new virtual currencies, over 1,500 and counting, only increased the confusion. The astonishing rise of Bitcoin value to nearly $20,000 per coin at the end of 2017 seemed to settle the debate once and for all. Droves of people jumped on the train to get a slice of the action, not deterred even by the subsequent drop in price. Trading volume remained at previously unseen heights, cementing the reputation of cryptocurrencies as the solution to the woes, such as the loss of credibility, the financial sector has been experiencing since the 2008 crisis.
Every tax season presents new challenges. This is no different for cryptocurrency enthusiasts. Several questions are on the minds of taxpayers. What are the tax consequences of digital currency transactions? How are such transactions valued? With all the hype surrounding cryptocurrencies, new articles on the tax implications are frequently released. Endless seminars, webinars and presentations are widely available and they all seem to have an opinion about what is includible on the U.S. tax return. Amidst all this noise, precious little authoritative guidance had been issued.
The Internal Revenue Service issued its first guidance on cryptocurrencies in April of 2014. IRS Notice 2014-21 declares that virtual currencies are not to be treated as currency. Instead, they are considered as property for U.S. federal tax purposes and all the general rules regulating property transactions apply. Gain or loss is to be calculated on the fair market value of cryptocurrency exchanges and the character of the gain or loss is determined by the nature of the asset in the hands of the taxpayer. Furthermore, the notice states that the mining of new virtual currencies constitutes 1) a business activity subject to self-employment tax; and 2) compensation paid in cryptocurrency for employment has all the payroll and withholding requirements similar to regular compensation. Since the 2014 notice, the IRS has reminded taxpayers that failure to report income from cryptocurrencies accurately and completely is subject to civil and criminal penalties.
To complicate matters, the worldwide acceptance and exchange of ever more cryptocurrencies has enticed fans to trade various virtual currencies on foreign exchanges or to hold their coins in overseas accounts. For example, foreign exchanges often require their clients to establish accounts for the storage of digital currencies, called cryptocurrency wallets, in order to participate in trading activities. The ownership of these accounts can trigger foreign informational form filings, such as FinCEN Form 114 (also called Foreign Bank Account Report or FBAR) and its sister form, IRS Form 8938. The filing threshold for FinCEN Form 114 is $10,000 any time during the tax year in the aggregate taking all reportable account values into consideration.
Fortunately, there are some planning opportunities available to owners of cryptocurrencies. For instance, charitable giving has a long history of coming to the aid of taxpayers looking to reduce their tax burden. Capital gains tax can be avoided on the contribution of cryptocurrency that is held for over a year, if it is made to a qualifying charity, and taxpayers are able to deduct the fair market value of the donated cryptocurrency as of the date of the gift.
Understanding the tax filing requirements of cryptocurrencies can be challenging even for the most educated of virtual currency investors. The Kerkering Barberio International Tax Team in Sarasota, Florida has the expertise and the experience to help taxpayers with both their U.S. tax return and foreign informational filings.