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Do You Have to Pay Taxes on Your Bitcoin?

Do You Have to Pay Taxes on Your Bitcoin?
The Basics of Cryptocurrency Taxation

Crypto and Taxes
Cryptocurrency (Crypto) has become one of the hottest topics in investing this past year.  Millions of people dove head first into the world of crypto, hoping to take advantage of the steadily increasing prices.  However, millions of users somehow forgot an unfortunate downside of making money: taxes.  In this post, we will touch on some of the information you will need to know for your income taxes if you were one of those millions of people who indulged in cryptocurrency.

Some Numbers
According to a study conducted by Dr. Garrick Hileman and Michel Rauchs of Cambridge, the number of Bitcoin users in March of 2017 was between 2.9 and 5.8 million users.  Since then, the number of users has nearly tripled to about 13 million active Coinbase users.  However, only a small portion of these users are reporting their earnings on their income taxes.  According to Credit Karma, of the 250,000 individuals who filed tax returns with them in 2017, less then 100 reported cryptocurrency transactions.  Because of this, the IRS is cracking down on the reporting of cryptocurrency transactions on income tax returns.

IRS Guidelines
The IRS issued tax Notice 2014-21 in 2014 containing a set of  guidelines on the reporting of virtual currency.  In this notice, the IRS classifies cryptocurrency as property rather than currency.  In other words, in the eyes of the IRS, cryptocurrency is viewed the same way as stocks and bonds, meaning it is a capital asset subject to the capital gains tax rules.  Therefore, the gains you made on cryptocurrency during the year must be reported on a Form 8949 because they are a product of investing activities.  In addition, just like losses on stocks and bonds, losses on cryptocurrency can be deducted against taxable income.  However, it is also important to keep in mind that there are other cryptocurrency transactions outside of investing activities that may be taxable at ordinary income tax rates.  These transactions include exchanging one cryptocurrency for another, hard forks, and airdrops.  For more information on these topics, please refer to the Tax Advisor article attached in the “Conclusion” section of this post.  Because cryptocurrency is still fairly new, it can be somewhat difficult to calculate taxable income on your cryptocurrency transactions.

Unlike brokerage firms, Coinbase does not issue a Form 1099 unless you have made gains greater than $20,000 or incurred more than 200 transactions.  Therefore, it is up to the user to find out what their actual gains and losses are for the reporting period.  This can become difficult, so it is important to record your transactions to make it easier for you when it comes time for tax season. 

Taxpayers may be tempted to not report their gains and losses on their income taxes.  After all, how would the IRS possibly find out if cryptocurrency transactions weren’t reported on income tax returns?  Well, for one, blockchain is a public ledger, meaning your cryptocurrency transactions are public knowledge.  And if that wasn’t enough to scare you into reporting this information, the IRS issued Notice 2018-71 stating the fines for not reporting virtual currency transactions could be as extreme as up to 5 years in prison and a fine up to $250,000.  So, in other words, report your gains and losses on cryptocurrency transactions.

Conclusion
In short:

  • Cryptocurrency is reportable as property on your tax return.
  • Sale of cryptocurrency is considered a capital gain or loss due to investing activities.
  • Transactions must be reported on a Form 8949.
  • It is the user’s responsibility to keep track of basis, gain, and loss.
  • Penalties for not reporting virtual currency transactions could be costly.

Please refer to IRS Notice 2014-21 for more information regarding the tax treatment of cryptocurrency at https://www.irs.gov/pub/irs-drop/n-14-21.pdf or contact a member of the Herbein tax team.

 Article written by Richard M. Staniszewski.