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As Bitcoin and other virtual currencies have exploded onto the scene over the last decade, savvy investors have begun taking note of the investment opportunities presented by this new technology. Many have begun to buy and sell Bitcoin in the same way they trade stocks and bonds. For those considering dipping their toes into the virtual currency market, one of the greatest concerns is often the kind of tax consequences that come with such investments.
At the Tax Law Offices of David W. Klasing, our Irvine Bitcoin and virtual currency tax attorneys and CPAs have been working in the new frontier of virtual currency tax law for several years. We have successfully guided many clients through the record-keeping and reporting procedures required to file a tax return including earnings from virtual currency. We have also fought for those who have been accused by the IRS of failure to report and helped them to stave off more serious penalties. If you are interested in scheduling a consultation, call us today at (800) 681-1295.
Understanding Bitcoin and Virtual Currencies
Bitcoin is a form of decentralized, virtual currency that was introduced in 2009 by an anonymous person or group of people known as Satoshi Nakamato. It is decentralized because transactions can occur person-to-person without the use of an intermediary like a bank or other financial institution. This allows for more private transactions and allows users to save money on banking and transaction fees.
The actual “bitcoin” itself is essentially just computer code. It exists in the form of a secure file that is powered by an open-source code known as a blockchain. Each transaction involving the bitcoin is represented as a “block” on the “chain” of the code. High powered computers are used to verify each transaction as it becomes part of the permanent record kept by the blockchain. The blockchain them serves as a public ledger of all transactions involving that bitcoin, but without revealing the identity of anyone involved.
Bitcoin has a deliberately built-in artificial scarcity as part of its system which makes it impossible for more than 21 million individual bitcoins to ever exist. More than 15 million bitcoins have already been discovered through a complex, computer-based process known as mining. When all 21 million have been mined, no new bitcoins will be created. The value of bitcoin thus goes up and down with supply and demand, depending on how much bitcoin is currently available in the market.
Many other types of digital currency have come into existence following the success of bitcoin. Most of these alternative forms also use blockchain-powered technology. Many online exchanges exist, and the value of a digital currency can also vary depending on which exchange the valuation comes from. Many investors buy and sell Bitcoin and other virtual currencies like stocks. Some companies are beginning to accept it as payment, and some employers are even beginning to use it for payroll.
Tax Consequences of Buying and Selling Virtual Currency
While using virtual currency can save you money in banking fees, it does not free you from scrutiny by the IRS. In recent years as the use of this currency has risen, the IRS has become more serious about its enforcement efforts related to failure to report virtual currency on tax returns as required. The IRS defines virtual currency as a “digital representation of value” that is not recognized as the legal tender of any country. For tax purposes, this means it is classified as property, like stocks or real estate, rather than as currency, like U.S. dollars.
Virtual currency, as property, is subject to the capital gains tax. You must report all capital gains and losses on Schedule D of your tax return each year. To calculate these, you need to keep track of the fair market value of a bitcoin on the dates you bought each of yours. Buying bitcoin is not a taxable event, but when you sell the bitcoin or use it to purchase something, taxes will be calculated based on any capital gains. Exchanging one type of cryptocurrency for another will also lead to capital gains or losses. To calculate capital gains, you subtract the fair market value of bitcoin on the day your purchased it from the price at which you sell or exchange the bitcoin.
Extensive records must be kept to properly calculate all capital gains and losses. If you possess the bitcoin for less than a year before selling, a short-term capital gains tax will apply at the ordinary graduated income tax rates that rise with the amount of adjusted gross income you report. If you possess it for a year or longer, a long-term capital gains tax will be assessed at up to 20%, plus a 3.8% net investment tax depending on your income bracket. Capital losses can be written off to offset gains taxes, but you cannot write off more than $3,000 of net capital losses in a year and capital losses cannot be carried back to previous tax years. An experienced virtual currency tax lawyer like those at the Tax Law Offices of David W. Klasing can help you determine your tax liability and reporting requirements.
What If I Am Paid for My Services in Cryptocurrency or Mined Cryptocurrency?
Although it is still quite uncommon, some individuals are paying employees and independent contractors in Bitcoin or other forms of Cryptocurrency. If you are paid in Crypto or mine Crypto, you must report this as ordinary income subject to self-employment tax on your tax returns, rather than as capital gains related to property as you would if you had simply bought and sold Cryptocurrency. If you are an employee, your employer will be required to calculate and withhold the standard payroll taxes. If you are an independent contractor, you will likely have to pay self-employment taxes on these earnings. For these more complicated types of situations, it is best to contact a tax attorney for in-depth, individualized advice.
What if I Received a Letter from the IRS About My Unreported Cryptocurrency Transactions?
This can very easily result in an eggshell audit or criminal tax investigation if not handled properly. Many cryptocurrency traders are shocked to learn that their exchanges of one type of crypto for another were taxable in the year of the exchange. With the huge rise in the market in 2017 followed by the collapse of the market in 2018 and beyond many investors are finding themselves with huge tax liabilities without the value in their remaining portfolio to cover the taxes owed. Many trades are shocked to learn that the IRS may have obtained their information from a John Doe summons of Coinbase or another cryptocurrency brokerage. We have extensive experience in dealing with all facets of crypto including air drops. Keeping your cryptocurrency offshore creates tremendously more exposure. Lastly, we are very accustomed to investors that had crypto with a brokerage that folded or was shut down and the complications that causes.
Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-reported cryptocurrency transactions) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation/prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.
A letter from the IRS regarding unreported cryptocurrency does not automatically make a voluntary disclosure unavailable.
It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.
Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for voluntary disclosure.
As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, Kovel CPAs and EAs, our firm provides a one-stop-shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!
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If You Have Questions About Virtual Currency Taxes, Call Our Irvine Tax Attorneys Today
Tax issues involving Bitcoin can be difficult, especially for those who are filing to report virtual currency for the first time. At the Tax Law Offices of David W. Klasing, our virtual currency tax attorneys have years of experience helping our clients to properly report and pay their taxes on these types of earnings. We have also represented clients who have had charges filed against them by the IRS for failure to disclose, and we have brought many of these cases to a successful conclusion. To schedule a free consultation, call us today at (800) 681-1295.
See our Bitcoin and Cryptocurrency Q and A Library
More Questions and Answers About Bitcoin
- What to Do When IRS Wants My Bitcoin Trade History
- Bitcoin Tax Record Keeping
- Can I Appeal a Bitcoin Tax Determination by the IRS?
- Why does BitCoin and other types of Virtual Currency draw so much attention from the Taxing Authorities and the Federal Government?
- Where is the most current IRS guidance on Virtual Currency found?
- Should You Report Bitcoin on Your Taxes?
- What Is Bitcoin?
- How does the IRS treat Bitcoin?
- Can I Face Tax Penalties for Mistakes Made with Bitcoin?
- How Does a Business Determine Its Taxes When Paid in Bitcoin?
- Who Pays the Taxes in a Bitcoin “Mining Pool?”
- Are Bitcoin Miners Required to Pay Self-Employment Tax?
- Can Bitcoin Trading Create an Obligation to Pay Capital Gains Taxes?
- What Is Bitcoin Digital Currency and Why Does it Matter for Tax Purposes?
- What Happens if the IRS Thinks I’m Using Bitcoin to Commit Tax Evasion?
Regardless of your business needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.In addition to our main office in Irvine, the Tax Law Offices of David W. Klasing has unstaffed (conference room only) satellite offices in Los Angeles, San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland, Carlsbad and Sacramento. During the COVID-19 pandemic, our staff are working from home, but have full virtual meeting capability.
Our office technology allows clients to meet virtually via GoToMeeting. With end-to-end encryption, strong passwords, and top-rated reliability, no one is messing with your meeting. To schedule a reduced-rate initial consultation via GoToMeeting follow this link. Call our office and request a GoToMeeting if you are an existing client.
