IRS to crypto investors: Don’t forget your taxes – or else
Thousands of cryptocurrency investors recently began receiving warning letters from the IRS reminding them that virtual currencies are considered property and taxable.
While Bitcoin and other cryptocurrencies can be used like cash and some merchants are now making it easy to use for purchases, the IRS treats the reporting of virtual currencies similarly to stock. That means you are required to account for every transaction and possibly pay capital gains tax on any profits from the investment.
Additionally, many cryptocurrency exchanges are located offshore, which could trigger the need for filing a Foreign Bank Account Report if the amount of virtual currency held exceeds $10,000 at any point in the tax year.
If you invest in cryptocurrency and especially if you receive an IRS letter, it’s time to consult with your financial advisor. Last year the IRS launched its “Virtual Currency Compliance Campaign” and warned the agency would, “remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.”
The IRS is also going after virtual currency exchanges to get client records. Last year, Coinbase was compelled to turn over information on about 13,000 customers to the IRS.
If you invest in cryptocurrencies, or are thinking about it, the following may help you stay out of trouble.
Account for every transaction
The IRS considers virtual currency – the type that can be digitally traded and purchased or exchanged into U.S. dollars or other real or virtual currencies – like property, subject to taxation. In fact, financial advisors note that despite the “currency” in the name, virtual currencies are treated more like stock, subject to capital gains taxes.
That means if you sell Bitcoin to buy Ethereum, you need to figure out the value of your Bitcoin and track whether you were selling at a gain or loss. Then you need to determine the value of the amount of Ethereum you’re acquiring and that becomes your basis for the investment. When you sell the Ethereum, that basis will determine if you have capital gains to declare or a capital loss.
Remember: You must save every transaction email or document and losses are as crucial as gains. For example, if you take a $30,000 loss in a Bitcoin sale but cannot prove it is a loss, the IRS will consider the proceeds from sale a taxable gain. Because virtual currencies receive the same treatment as stock, investors are advised to save every transaction email or document.
Keep capital gains tax in mind if you consider using virtual currency to buy real goods. For example, if you use some Bitcoin profit to buy a new car, when tax time comes you could be paying more than expected. In addition to the normal sales tax, you may have income tax to pay on the gain realized when you sold the Bitcoin to buy the car.
Offshore crypto wallets
U.S. taxpayers are required to file a Foreign Bank Account Report, or FBAR, for foreign bank or securities accounts that exceed $10,000 at any point in the tax year.
Failure to file an FBAR can draw civil and criminal penalties starting at $12,459 for non-willful failure to file. In cases of willful failure to file, the civil penalty is the greater of $124,588 or 50 percent of the highest account balance in all foreign accounts during a six-year period per year, plus any tax owed, interest, and additional penalties. Criminal penalties could also apply. The standard for what is “willful” is evolving and that standard is getting lower.
Because many virtual currency exchanges are overseas – meaning the investor’s crypto wallet is held in an offshore account – FBAR filing regulations appear to apply. Notice we say “appear” – the regulations in this area are still evolving, but our advice is to file the report to be on the safe side.
Earlier this year the American Institute of Certified Public Accountants asked the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) for clarification and was told virtual currency holdings in non-U.S. exchanges are not reportable on the FBAR, at least for now. But FinCEN did say, “in consultation with the IRS, continue[s] to evaluate the value of incorporating virtual currency held offshore into the FBAR regulatory reporting requirements.”
We agree with AICPA’s advice on offshore cryptocurrency accounts that, “absent this clarity, the conservative approach would be filing the FBAR.’’
With the IRS pouring over cryptocurrency transaction records, you don’t want to play audit roulette. Especially if you’ve received one of the IRS letters, better to figure out what you owe and then talk to an accountant about filing an amended return.
Additionally, keep in mind the need to stay focused on proper record keeping of all your virtual currency transactions. The rules can be confusing, and the consequences for noncompliance harsh.
Edward R. Jenkins, CPA, CGMA is a Tax Consultant with Boyer & Ritter LLC Certified Public Accountants and Consultants and a Professor of Practice in Accounting at Pennsylvania State University. Contact Ed at 814-234-6919 or firstname.lastname@example.org