The IRS’s decision to characterize virtual currency such as Bitcoin as property rather than currency resulted in a number of tax impacts. Fundamentally, treating Bitcoin and like cryptocurrencies as property opened the door to issues concerning capital gain and capital loss. That is, when property is sold or otherwise transferred, a tax payer is generally obligated to compute gain or loss on the property. If the property has increased in value, potentially significant capital gains taxes may be due. If the cryptocurrency was acquired because of mining activity it results in self-employment income at the value of the cryptocurrency on the date received.
However, there is still a great deal of confusion concerning the proper method of accounting for and reporting Bitcoin and other cryptocurrency transactions, income, and taxes. In fact, the still developing state of the law regarding the handling of virtual currencies suggests that taxpayers would be prudent to routinely engage in compliance audits based on a current but evolving understanding of the law. One area where it appears that mistakes and insufficient legal filings may be rampant involves the reporting of Bitcoin and other cryptocurrency capital gains and losses and self-employment income from mining activity.
In fact, while it is generally required for taxpayer to file an 8949 when reporting Bitcoin and cryptocurrency transactions as part of a tax filing, it appears that compliance is shockingly low. One study seems to suggest that while taxpayers may have an obligation to file 8949s along with their Schedule D, many do not. Despite the belief that at least hundreds of thousands, if not millions, of people utilize Bitcoin and other cryptocurrencies, the IRS found that a very small percentage is filing the 8949. The IRS study found that:
While the study is imperfect and relies on the description provided by the taxpayer, it is clear that filings are far below the numbers that the level of Bitcoin activity should suggest.
Generally, when taxpayers have engaged in Bitcoin transactions, Form 8949 should be included along with 1040 Schedule D. Per the instructions set forth for a Schedule D filing, a taxpayer should:
Use Form 8949 to report the sale or exchange of a capital asset (defined later) not reported on another form or schedule. Complete all necessary pages of Form 8949 before you complete line 1b, 2, 3, 8b, 9, or 10 of Schedule D. See Lines 1a and 8a, later, for more information about when Form 8949 is needed and when it isn’t.
Thus, Form 8949 should typically be included when a capital asset has been transferred. In many scenarios, virtual currency is likely to qualify as a capital asset. The Schedule D instructions include “virtual currency” as an “item for special treatment” and directs users to the IRS 2014 virtual currency publication. The publication states that Bitcoin and cryptocurrency capital gain and loss is realized when Bitcoin/cryptocurrency is a capital asset in the hands of the taxpayer. While taxpayers who are currency dealers or otherwise hold Bitcoin as inventory mainly for sale to customers are an example of individuals who hold bitcoin as a non-capital asset, most other taxpayers who hold Bitcoin/cryptocurrency will do so as a capital asset. Therefore, individuals holding Bitcoin/cryptocurrency as a capital asset will generally have an obligation to report their gain or loss via a filing of Form 8949 to supplement Schedule D.
As a starting point, it is first essential to note that many of the reports prepared and made available by popular Bitcoin/cryptocurrency exchanges and wallets may be insufficient for tax purposes. Many users of Bitcoin and virtual currency will use an array of wallets and services. If you engage in practices like this where you use a variety of virtual currency services, a single wallet or exchange cannot determine what occurred prior to importing the Bitcoin or after it has been exported to another exchange or printed. As such, the statements provided may be inaccurate for the taxpayer’s gain or loss calculations. Thus, the first step in preparing a Bitcoin/cryptocurrency tax filing is to ensure that gain and loss for individual transactions is accurately computed.
This information should be input on a Form 8949 for each transaction or other reportable events. Once the information has been input on one or more Form 8949s, totals from the separate 8949s would be totaled on Schedule D. Thus, Schedule D will provide an overall, big picture view of gain and loss while the 8949s will provide a more detailed view of individualized aspects of the overall gain or loss. Working with a tax lawyer can help you comply with all tax laws and avoid an audit triggered by Bitcoin/cryptocurrency capital gains or losses and or self-employment income.
If you have a multiyear history of unreported capital gain and self-employment income from trading, spending or mining Bitcoin and other cryptocurrencies you would be wise to consult with a Tax Lawyer. Only a Tax Lawyer can discuss your compliance issues, which could be potentially viewed by a taxing authority as caused by tax fraud, under the attorney client privilege. Only a Criminal Tax Defense can accurately assess the risk of criminal prosecution inherent in cryptocurrency noncompliance scenarios and advise on whether a quite or loud voluntary disclosure is warranted. Contact the Tax Attorneys and CPAs of the Tax Law Offices of David W. Klasing for help as soon as possible. To schedule a confidential reduced rate consultation, please call our Irvine or Los Angeles tax law offices at 800-681-1295 or schedule online today.