The IRS has increased scrutiny on Bitcoin and other cryptocurrency transactions in its effort to make those aware who previously neglected to declare these forms of virtual investments. The first question on the 2020 tax year Form 1040 for individuals asks about virtual currency transactions. However, the degree to which the investment is taxed depends on a person’s overall income and how long the currency has been held.
If the cryptocurrency was held for one year or less, it is considered short-term capital gains, and profits will be taxed at the overall income rate. Any profits earned on virtual currency that is held longer than one year is considered long-term capital gains and, depending on annual income, are normally taxed at a lower rate.
Purchases made using virtual currency.
Quite a few people invested in Bitcoin when it was relatively low, and many crypto investors decide to sell in 2020 to make a quick profit while the market was high. In addition to declaring capital gains, the IRS also expects a report to be made on gains and losses attached to crypto investment activity or purchases made using cryptocurrency such as Bitcoin.
For example, a crypto investor uses a $10,000 Bitcoin to purchase a new $2,500 computer – an asset that depreciates in value. The IRS expects a calculation based on the value of the Bitcoin at the time of the transaction and recognize any capital gains or losses relative to the cost or fair market value.
Whether or not an investor sold or retained cryptocurrency in 2020, for federal tax purposes, all virtual currency is treated as property; therefore, general tax principles applicable to property transactions also apply to transactions using virtual currency. Even purchasing a cup of coffee with cryptocurrency has tax implications.
Crypto used for services.
Many companies in the tech industry have begun paying employees with Bitcoin and other cryptocurrencies. While the practice is a bit of a novelty, some firms see this as a way to attract more tech-savvy talent.
Both employee and employer should keep a record of the fair market value of the crypto paid as wages, measured in U.S. dollars at the date of receipt. These wages are subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA), and Federal unemployment taxes. All must be reported on Form W-2, Wage and Tax Statement.
On the flip side, employers who pay for services using virtual currency held as an asset must evaluate capital gains or losses for that exchange. The gain or loss is determined by the difference between the fair market value at the time of the exchange for services received and the adjusted basis in the virtual currency exchanged.
Charitable donations and crypto.
Donating to charity through cryptocurrency can reduce tax liability on the investment According to IRS code Section 170(c), donations made to a charity using virtual currency will not be recognized as income, gain, or loss from the donation. Any charitable deduction made would be recognized as being equal to the fair market value of the virtual currency at the time of donation, provided the investment has been held over a period of one year. Any deductions made using cryptocurrency held for a year or less would be based on the lesser of the virtual currency or the value of the currency at the time of the donation.
Charitable organizations that receive virtual currency should treat the donation as a noncash contribution and can assist a donor by providing the contemporaneous written acknowledgment, something the donor must obtain if claiming a deduction of $250 or more for the virtual currency donation.
It is important to maintain detailed records of all cryptocurrency transactions. This includes receipts and the amount of purchases or donations, plus the value of the virtual currency on the date of each transaction.
For other questions regarding the tax treatment of virtual currency, refer to Notice 2014-21 and Rev. Rul. 2019-24.
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.