Often, when I get into discussions about cryptocurrency or virtual currencies, I hear people say or imply that they can avoid taxes with cryptocurrency – as in, avoid ALL taxes with cryptocurrency.
Now, I don’t have any knowledge on how easy it is to hide money and hide transactions with cryptocurrency, but as an Enrolled Agent who represents taxpayers before the IRS, I do know:
- What the IRS expects regarding crypto and taxes
- That the IRS, the US Treasury Department, and the Securities and Exchange Commission (SEC) are increasingly focusing on cryptocurrency
The IRS has reporting requirements for individuals and institutions. So, if it has been easy to hide crypto and avoid taxes in the past, it is already less easy, and you can expect it to get harder.
My advice is to follow the law and minimize taxes legally.
Let’s talk about how the IRS views virtual currencies.
What is Virtual Currency?
The IRS says that “virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”
Additionally, they say that “cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, (i.e. blockchain).
If a virtual currency has an equivalent value in real currency, or acts as a substitute for real currency, the IRS calls it a “convertible” virtual currency.”
Well, there you go, is that clearer?
Let’s get to the point of this article…taxes.
Is Cryptocurrency Considered “Property”?
According to the IRS (and the Treasury Department and the U.S. Government), the sale, exchange, investment in, or use of virtual currencies to pay for goods or services, generally has tax consequences.
The IRS considers virtual currencies to be property, therefore they are capital assets. This means, if there is a gain, that gain is subject to the capital gains tax.
Note: This applies when you are trading one cryptocurrency for another.
Under current law, if you use cryptocurrency to pay for a $100 meal and you paid $10 for that cryptocurrency, then you have just realized a $90 capital gain subject to capital gain tax.
The gain can be taxed at the short-term capital gain rate or the long-term capital gain rate, depending on how long you held the cryptocurrency. To get the lower, long-term capital gain rate, you have to hold the asset (cryptocurrency in this case) over a year, basically a year and a day or more.
Is Cryptocurrency Mining Considered Self-Employment?
If you are mining cryptocurrency, the IRS treats your taxes a bit differently. The IRS guidance is still evolving, but it appears there may be two different means to report crypto-mining as taxable income.
According to IRS Notice 2014-21, you must include any mined virtual currency’s fair market value in your gross income. The fair market value is how much your crypto was worth in U.S. dollars when you received it. This gross income is included as ‘Other Income” on Schedule 1 of your Form 1040. You generally cannot deduct business expenses, such as the cost of computer equipment and other related costs, from hobby income.
Trade or Business Income
However, if you mine crypto as part of a trade or business, then you’re
generating self-employment income in the IRS’s eyes. That means filing individual self-employment taxes and filing a Schedule C form in your tax return to report the income and expenses from your mining efforts. If you created a business entity for the mining, then you have to file a business return, which would then be reported on your individual tax return.
While you must pay self-employment tax on mining crypto as part of a trade or business, you generally are allowed to deduct certain costs of doing business.
You can find additional guidance on determining whether an activity is a hobby or business on the IRS website.
The fair market value of mined crypto becomes your basis. If you sell or have a transaction with the mined cryptocurrency after the value has changed – then you have a taxable gain or a loss.
Earning Interest on Cryptocurrency
If you have cryptocurrency in an interest-bearing account then the interest you earn is taxed as income (based on the fair market value of the cryptocurrency when it was earned as interest).
The interest’s fair market value determines whether you have a gain or loss when you use it in a transaction.
Including Cryptocurrency on my Individual Tax Return?
Since 2019 the IRS has required all individual filers to answer a question about virtual currency. If you answer yes, (and if the answer is yes, you should answer yes) then the IRS expects to see transactions and/or income reported on your tax return. When you report these transactions (gains, losses, and income) on your tax return, you’ll need to fill out additional forms like the Schedule 1, Schedule B, Schedule D, and Form 8949. This obviously complicates the tax return and increases the likelihood of errors.
Virtual currencies may hold great investment opportunity, just remember:
- If there is a way to make money, the government usually finds a way to tax it.
- Staying compliant with the tax code and the law is the best way to avoid legal problems.
- If you have generated “new” coins/currency or received crypto interest you have taxable income. If you use or exchange currency and there is a gain in value you have a taxable gain.
If you find dealing with cryptocurrency on your tax returns to be more than you’d care to deal with, then you may want to consult a tax professional with cryptocurrency experience. I am happy to help. You can contact me here.
You can find more information at IRS.gov.
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