Can the IRS Track Bitcoin and Other Cryptocurrencies?
A new proposal from the Financial Crimes Enforcement Network (FinCEN) on December 18th, 2020, would make it much easier for the government to track cryptocurrency. This change would affect cryptocurrencies held in private wallets and those that are held on trading platforms such as Coinbase. For example, sending a large sum of cryptocurrency to your private wallet would require a person to inform the government that they are the owner of the wallet.
Additionally, under the new regulation, cryptocurrency platforms must also make certain disclosures to the government depending on the transactions performed by users. For example, a platform that allows crypto transactions would have to report users that engage in trading of $10,000 of cryptos in one day.
While one of the main reasons for using cryptocurrencies like Bitcoin is anonymity, the U.S. is concerned about the financial crimes and other heinous activities that could be committed using virtual currencies. By collecting the identities of those that engage in the sale or exchange of cryptocurrency, the government hopes to curb crimes like money laundering and human trafficking.
However, these increased regulations mean a lot more paperwork for taxpayers and companies that facilitate the buying and selling of virtual currencies. Additionally, when a person or entity does not comply with the new reporting requirements, they could face severe penalties from the Treasury Department. For example, financial institutions could be issued daily penalties, and individual taxpayers may incur fines and be subject to criminal prosecution.
While every exchange of cryptocurrency is not currently tracked, it is a matter of time before more regulations impact the anonymity of crypto trading. Ensure that you are compliant with these new changes by working with our dual licensed California Tax Attorneys and CPAs.
What to do If I have multiple years of unreported cryptocurrency?
Cryptocurrencies, also referred to by the IRS as virtual currencies, are swiftly becoming popular among taxpayers across all income tax brackets. However, regulations surrounding cryptocurrencies are steadily changing as new types arise, and many businesses begin to accept payment from these currencies. To prevent the possibility of facing civil and criminal penalties for the incorrect tax reporting of cryptocurrency, you should learn how the IRS treats these currencies for tax purposes.
Rules for Cryptocurrency Taxation
The IRS taxes cryptocurrencies as property, often in similar ways as to the tax treatment of stocks. As a result, the exchange, sale, or purchase of goods or services using cryptocurrency will generally be recognized as a capital gain or loss. Additionally, accepting cryptocurrency as a form of payment in your business will trigger ordinary (rather than capital gain) income tax liability. Mining cryptos using computer software is also a taxable event that is subject to ordinary income tax and self-employment taxes.
To calculate your taxes for crypto transactions, you need to take your cost basis and subtract it from your proceeds in order to get your capital gain or loss. The cost basis of your cryptocurrency is the value of the virtual currency when it is acquired. The proceeds are calculated by looking at the amount of money earned from the sale of crypto or fair market value of the coins or property received for it in an exchange.
For example, a taxpayer would need to report capital gains of $2,000 if they purchased Bitcoin for $40,000 and sold it at $42,000. If they held the coins for less than a year the gain would be short term. If held for longer than a year the gain would be long term.
It is also important to note that cryptocurrency that is received for services rendered or where a product is sold will be treated differently than where a taxpayer is engaged in purely investing activity. When you accept crypto for services or product sold, you record it as ordinary income that will be taxed at your graduated income tax rate and will be subject to self-employment tax. Any eventual exchange or disposal of that cryptocurrency so acquired will then be reported as capital gains and losses.
To report cryptocurrency on your tax return, you will need to use Form 8949 for capital gain and losses. Every sale of cryptocurrency generating capital gains and losses should be reported using this form. Make sure that you have details of your cryptocurrency transactions ready, as Form 8949 will require you to answer the following questions:
Details of short-term and other crypto transactions
Dates when you acquired cryptocurrency and its value at that time
Dates when you sold or traded crypto assets
The proceeds or gross USD profit from the sale or use of cryptos
The total value of cryptocurrency transactions
The capital gains or losses when trading crypto
Engaging in the regular trading of cryptocurrency and reporting this trading could yield some confusing results. For example, you may exchange $40,000 worth of cryptocurrencies in a tax year but only gain a few hundred dollars from those trades. Remember to submit your Form 8949 with a Form 1040 Schedule D.
Our dual licensed California Tax Attorneys and CPAs could help you navigate complex cryptocurrency tax reporting.