Bitcoin, Ethereum, Litecoin… by now it’s likely that you’ve heard one of these cryptocurrency names come up in the news given the large investment interest they’ve continued to acquire. However, before investors and businesses engage in these cryptocurrencies it’s important that they understand the tax implications of doing so.
The most recent IRS guidance, Notice 2014-21, provides some insight surrounding the tax treatment of these cryptocurrencies. The IRS deems these cryptocurrencies to be more closely similar to property and taxed under the Internal Revenue Code Section 1001, rather than as currency under IRC 988. As a result, taxpayers who use cryptocurrencies to purchase goods are treated as having sold the cryptocurrency and subsequently used the proceeds to purchase the good; which will likely give rise to a taxable event. For most taxpayers the virtual currency will be classified as a capital asset, therefore generating a capital gain or loss on the difference between the fair market value when sold and the taxpayer’s adjusted basis.
Taxpayers who acquire these virtual currencies via “mining” are required to include the fair market value of the currency they’ve acquired as taxable income on the date of receipt. Those whose mining activities rise to the level of a “trade or business” must include this income as self-employment earnings subject to self-employment taxes. This fair market value taxed as income will then serve as the taxpayer’s basis when later sold.
Additionally, taxpayers who are paid via cryptocurrencies must include the value of these payments in their income. Employers who make payments of cryptocurrencies to their employees must determine the value of the virtual currency on the date of payment and calculate the respective employment taxes which are required to be remitted based on this value as if it were a payment of cash wages. These wages are subject to the Form W-2 reporting requirements and payments to contractors are subject to the reporting requirements of Form 1099-MISC.
Given the secretive nature of these virtual currency transactions, the IRS has begun exploring techniques to monitor and detect taxpayers who are not reporting or incorrectly reporting these virtual currency transactions. The IRS estimated that only 800 taxpayers reported virtual currency transactions from the years 2013-2015, clearly a far cry from the actual activity generated during this timeframe. Consequently, on November 30th, 2016 the IRS caused a U.S. District Court in California to issue a “John Doe Summons” to Coinbase, the largest virtual currency exchange. This summons allows the IRS to view customers engaging in transactions of $20,000 or more from 2013-2015, transaction logs, and correspondence. With cryptocurrencies exceeding $417 billion in market cap, look for the IRS to continue exploring aggressive ways to gain information as was previously done by the IRS for foreign reporting compliance.
Taxpayers who fail to report these transactions may be subject to penalties and interest and should consult with a member of Withum’s Technology Team to ensure proper actions are taken by filling out the form below.
 Market capitalization figures based on reported numbers from coinmarketcap.com as of December 8th, 2017