Cryptocurrencies, a type of virtual currency, are controversial everywhere around the world. One thing that is for sure, at least for the moment, is that they are here to stay. With BTC hitting over $50,000 and the US Securities and Exchange Commission approving a cryptocurrency stock exchange-traded fund (ETF), to China’s crypto bans, these coins are hot. What does that mean to you, the business owner?
Answers to FAQs About Cryptocurrencies and Your Business Taxes
The Internal Revenue Service considers virtual currencies to be property and the income associated with the sale of that property, or income received from your customers, any income at all for that matter, to be taxable. They are quite serious about it too. There are IRS agents dipping into the dark web to track down crypto currency traders, owners, and criminals
If you’re a business owner who has been active in the virtual currency market over the past few years, you may have noticed that beginning on your 2019 personal tax return this question appeared: “At any time during X YEAR, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”
Specifically, you’ll find this query on Schedule 1, “Additional Income and Adjustments to Income” which accompanies the 2019 and onward versions of Form 1040. You are required to check the box to affirm if you have actively used virtual currency during the tax year.
The reason why the IRS wants to know about crypto is pretty simple: virtual currency transactions are under a higher level of scrutiny to make sure they are taxed appropriately. If you are trading in virtual currency or are thinking about doing so, you need to understand these basic virtual currency tax rules:
- Crypto currency is not treated like cash. It is treated like stocks, bonds, and other investment properties. You need to report your holdings, gains and losses on Form 8949 and 1040 Schedule D.
- When you trade crypto currency to crypto currency (calculating its fair market worth in US dollars) or to a fiat currency like the dollar it is a taxable event. It is also a taxable event when you use crypto currency to purchase goods and services. You may also end up owing sales tax.
- Buying crypto currency with U.S. dollars is not a taxable event because you are not realizing gains when you do so. If you trade one type of virtual currency to the same kind in a wallet-to-wallet trade you may not obligated to pay tax, but you do have to account for it, depending on the exchange you are using. Make sure to check the tax rules of the specific exchange and the IRS accordingly.
- Gift tax rules apply if you give crypto currency as a gift that is larger than the annual exclusion amount, which is $15,000 for 2019. The recipient inherits the cost basis and will owe tax when they sell or trade it.
- If you are mining and using virtual currency as a business the general rule is that you must account for the dollar value of the coin at the time you received it and again when you trade it or use it. If you make a payment in crypto currency you must report it as well. If you receive a payment in crypto currency for your business, it is a taxable event. The rules for businesses are complex, so consider seeking the advice of a tax professional to help you.
- You must keep track of your gains and losses each year and deduct this from your cost basis. This makes it vital to keep track of the value of any trades you make in U.S. dollars at the time of the trade.
Keep in mind that the IRS is also retroactively looking into virtual currency transactions to identify taxpayers who may have failed to report income from them in the past. If you are part of this group, you’ll need to act now, amending any outstanding tax returns and paying the tax you owe as soon as possible to avoid fines, penalties or legal action by the IRS.
If you have questions about how to report your crypto currency on your 2021 tax return or on your previous years’ returns, now is the time to contact a tax professional to help you. This is one area that the IRS is clearly focused on both this tax year and for the foreseeable future.
Examples of how a business owner should report cryptocurrency to the IRS
First thing’s first. Don’t hide it. All governments around the world are taking high interest in these currencies and are not wanting to miss their tax income. The IRS has already issued a John Doe subpoena, a subpoena that targets a tax year rather than just one individual, to exchanges in the past and they will certainly do so again in the future. Be careful what wallets you chose and what exchanges you frequent. If you don’t want questions later, use an exchange that is already reporting the transactions to the IRS. It’s still a bit like the wild west in the crypto realm, so be careful.
As a business owner or freelancer, you are taxed on any income you receive, even if it is in BTC, ETH, or any other virtual currency form. You can also pay for services and supplies with crytos. As an individual or a business, you can invest in cryptocurrencies.
Here’s an example:
Your client, Mr. X, is into cryptocurrencies. He talks you into accepting payment from him in BTC. You agree and Mr. X transfers .5 BTC to your wallet. You think this is pretty cool and decide to pay for one of your business expenses associated with his project with .1 BTC.
Now the breakdown, using $50,000 USD as the value for the BTC at the moment of Mr. X’s payment, and what just happened to you.
You just made $25,000 USD as income and assuming the value of the BTC had not changed at the moment of your vendor payment, you spent $5,000 USD to that vendor. Leaving you with an overall profit of $20,000 USD.
Say you hold on to the remaining .4 BTC and decide later to buy another cryptocurrency with it. A friend of yours told you about ETH, which we will set for our purposes at $3,000 USD. You pick up 1 ETH for .06 BTC. This leaves 1 ETH and .34 BTC in your wallet.
You have also just made another reportable transaction. This time assume the value of BTC increased to $55,000 USD. You “sold” .06 BTC $1320 USD and “bought” 1 ETC for the same amount. Your cost or buy of that .06 BTC is $1200 USD (the value at which you received it). You have capital gains income of $120 USD on the sale of the BTC used to purchase Ethereum.
When do you need to talk to a CPA or tax advisor about cryptocurrency?
By the time you have negotiated the above transaction, if you haven’t called your tax advisor yet, you should. They can help you figure out what exactly is taxable to you and what isn’t. The above example was a simplified view and once you enter the world of crypto’s you will be initiated to terms like fiat (a medium of exchange established as money, according to Yahoo! Finance Australia, hard forks (an unstable time for a cryptocurrency) and FUD (fear, uncertainty, doubt).
Another piece of advice, don’t think that leaving all that in your wallet(s) and using exchanges in Russia or some other such country will not make these coins taxable to you. There is no “out of sight, out of mind” here. Just because the funds haven’t hit your bank account yet, doesn’t mean that the event did not exist.
Talk to a tax professional if you want to use cryptocurrency for business transactions.
Leaving all this FUD behind, cryptocurrencies by themselves are an intriguing entrant on the currency market. By opening yourself up to accepting crypto’s as a payment method for your customers, you pave the way for a myriad of possiblities.
It’s key to team up with someone who can help you tame the wild west and make it easier for you to understand and track these events as they happen throughout the year. There is nothing more painful than pulling all of your transactions from all the exchanges at tax time and trying to make sense of it. Well, there is one thing more painful, that’s the tax you could end up with bill if you don’t plan ahead!