Should You Report Bitcoin on Your Taxes?

The IRS is on the Hunt for Bitcoin Tax Evaders. Last Thursday, the Department of Justice filed a broad request in federal court requesting the identities of all customers who bought virtual currency from Coinbase, the largest Bitcoin exchange in the U.S., between December 31, 2013, and December 31, 2015.

The document is referred as a “John Doe” summons, which can only be served by the IRS after federal court approval. The summons provided that there is a reasonable basis for believing that United States taxpayers have failed to comply with the internal revenue laws.

A statement from an IRS Senior Revenue Agent, David Utzke, outlined three cases in which persons used Bitcoin to evade taxes, including one involving Coinbase customers. Two companies were identified as misreporting purchases of Bitcoin as technology expenses, rather than treating them as property, or inventory.

Although the summons’ main objective is to pursue larger offenders, small-time Bitcoin users are of interest, since they likely are not recording their virtual currency transactions properly.

 

 

Tax Implications and Reporting Requirements

The tax implications of using Bitcoin may seem similar to shares of stock or securities in that records need to be maintained in order to track basis of each bitcoin; however, wash sales likely do not apply to bitcoins since they do not meet the definition of a stock share.

The IRS did indicate that the normal basis rules would apply to bitcoins, therefore Bitcoin users would have the option to sell their assets on a first-in-first-out (FIFO) basis, a last-in-first-out (LIFO) basis, or a selective cost-basis method. In a rising market, LIFO will produce the lowest tax liability, while FIFO will do so in a falling market.

Besides maintaining records for tracking basis, taxpayers should also be aware that if they are paid with bitcoins for their services, the bitcoins constitute self-employment income and therefore subject to self-employment tax.

Further, a person who in the course of a trade or business makes a payment using virtual currency may have a Form 1099-MISC reporting requirement if the value is $600 or more to a non-exempt recipient. Accordingly, backup withholding could apply.

Penalties for Failure to Comply

Most Bitcoin users were not aware that they were supposed to record their gains and losses as taxable events each time they made purchases with their bitcoins or sold them for money. Because of the recent John Doe summons, they are at risk for tax evasion. Consequently, they may be subject to penalties for failure to comply with tax laws. Underpayments attributable to virtual currency transactions include accuracy-related penalties and information reporting penalties. However, penalty relief may be available to taxpayers and persons required to file an information return who are able to establish reasonable cause.

The Importance of Contacting an Experienced Tax Attorney as Soon as Possible

The tax and accounting professionals at the Tax Law Offices of David W. Klasing have extensive experience in working with taxpayers who are noncompliant and may be subject to penalties. Our zealous advocates are ready to gather the facts specific to your situation and develop a personalized strategy. We can help you with reaching full compliance and recording your virtual currency transactions for tax purposes. Contact the Tax Law Offices of David W. Klasing today for a reduced-rate consultation.