The Internal Revenue Service (IRS) issued updates to its Frequently Asked Questions on Virtual Currency Transactions in January. With the IRS emphasizing cryptocurrency tax compliance in 2022, investors and businesses that held Bitcoin or other virtual currencies during the 2021 tax year need to ensure that they are meeting their federal obligations, and reviewing the IRS’ FAQs is a good place to start (although taxpayers cannot rely on these FAQs exclusively). In this article, Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, covers some of the highlights:
Cryptocurrency is Treated as Property for Federal Tax Purposes
The IRS announced in 2014 that it would be treating cryptocurrency as property for federal tax purposes, and it has held strong ever since. This means that as a baseline, cryptocurrency transactions trigger either taxable income or an income deduction—as these transactions result in taxpayers realizing either gain or loss.
U.S. Taxpayers Need to Report All Cryptocurrency Transactions
Under federal law, cryptocurrency investors and businesses that accept and exchange cryptocurrency must report all cryptocurrency transactions on their federal returns. While Representative Suzan DelBene (D-WA) has introduced a bill that would exempt de minimis cryptocurrency transactions resulting in a gain of less than $200 each of the past three years, the bill has never been able to gain traction in Congress.
Payments for Goods and Services Made with Cryptocurrency Count as Income
While investors generally do not incur tax liability upon purchasing cryptocurrency, receiving virtual currency in exchange for goods or services is a taxable event. This is true for businesses, independent contractors and employees. As the IRS explains, “The amount of income you must recognize is the fair market value of the virtual currency, in U.S. dollars, when received. In an on-chain transaction, you receive the virtual currency on the date and at the time the transaction is recorded on the distributed ledger.”
Paying for goods or services with cryptocurrency is also a recognition event for the customer. “If you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss.”
Receiving Cryptocurrency as a Gift Is Not a Taxable Event
In contrast to receiving cryptocurrency in exchange for goods or services, receiving cryptocurrency as a gift is not a taxable event. The recipient’s tax liability, if any, accrues upon disposition of the gifted cryptocurrency—with the recipient’s tax basis being determined based on either the donor’s basis or the fair market value of the cryptocurrency at the time of the gift depending on the circumstances.
U.S. Taxpayers Can Choose Which Units of a Cryptocurrency to Attribute to a Particular Transaction
The rules discussed above are subject to the caveat that U.S. taxpayers can choose which units of a cryptocurrency to attribute to a particular transaction. For example, if a taxpayer acquired two Bitcoins in two separate transactions and subsequently sold one, the taxpayer can choose to attribute the Bitcoin with the higher basis to the transaction—thus mitigating the taxpayer’s cryptocurrency tax liability. In the words of the IRS:
“You may choose which units of virtual currency are deemed to be sold, exchanged, or otherwise disposed of if you can specifically identify which unit or units of virtual currency are involved in the transaction and substantiate your basis in those units.”
Contact Boston Tax Attorney Kevin E. Thorn
If you need help dealing with the IRS on a cryptocurrency-related matter, Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, can assist you. To schedule a confidential initial consultation, please call 617-692-2989, email firstname.lastname@example.org or contact us online today.