Virtual Currency Tax Update

Covid-19 has stifled the IRS’s enforcement arm. Many of the agency’s audit activities were curbed from mid-March to July 15 because of the pandemic, and the IRS is slowly stepping back into doing exams. But the IRS hasn’t lost focus of its key priorities. On that list are virtual currency transactions. According to the IRS Commissioner Charles Rettig, the IRS remains very active in increasing tax compliance in emerging areas such as virtual currency.

Virtual currency is treated as property for tax purposes. This includes bitcoin and other forms of similar digital representations of value that act as a substitute for real currency. Taxpayers who sell or exchange virtual currency will recognize gain or loss on the transaction. The profit or loss will be capital gain or loss if the bitcoins were held for investment, similar to stocks or bonds. If you held the virtual currency for more than one year before selling or exchanging it, then the capital gain or loss is long-term and subject to preferred tax rules. Otherwise, it is short-term.

Taxpayers who accept bitcoin as pay for service have ordinary income equal to the value in the U.S. dollars on the date of receipt. Your tax basis in bitcoin is that same value. Employers that pay wages with bitcoin or other cryptocurrency report the U.S. dollar value on W-2s. Ditto for businesses that send out 1099 forms.

The IRS issued further guidance on the taxation of virtual currency last year. Among the topics addressed was donating or gifting cryptocurrency, determining tax basis and holding period in virtual currency received for services or the sale of property, and tax consequences when the currency is split into two as a result of certain software changes, commonly referred to as hard fork. Plus tax return reporting. The IRS has a set of FAQ’s on its website with more details.

The Kiplinger Tax Letter
October 2020