Since the release of Bitcoin in 2009, more than 4,000 alternative currencies have emerged in the decentralized banking market. For nearly 10 years, the IRS has sought to gain a foothold in what has since become a booming market with a rising number of participating asset holders. The recent Coinbase, Inc. case ruling makes it clear that the United States government is intent on pursuing digital currency holders who aren’t fully transparent in their online activity. In her decision handed down last November, Magistrate Judge Jacqueline Scott Corley in the U.S. District Court, California Northern District, said virtual currency exchange Coinbase must give the Internal Revenue Service information on accounts with transactions of greater than $20,000 — a decision that constituted a partial win for the IRS in its bid to seek records from the exchange. In order to avoid heavy fines of up to $250,000 and possible prison time, it is now more important than ever to properly document and report all digital currency transactions.
Here are five essential best practices for reporting digital assets that can save those who engage in bitcoin transactions from big tax penalties.
- Know the cost basis. The IRS considers cryptocurrency and digital currency property for tax purposes and may prosecute anyone neglecting to report it on their taxes. Some virtual exchanges provide a form 1099-K to their clients; most, however, do not, making it the client’s responsibility to determine the value of his digital assets. This is very important as it will affect the client’s taxability when he sells.
- Remember that mined currency is income. If a person is paid for an activity, he must pay both income tax on the amount mined plus self-employment taxes, where applicable. Mining of cryptocurrency is the process of adding transaction records to the blockchain, or public ledger of past transactions, and the person doing that mining must include in his gross income the value of that cryptocurrency on the day it was received.
- Track and report all cryptocurrency purchases and sales. If cryptocurrency is used like cash, every purchase made – including that of goods and services – is a taxable event, and the purchaser must track details, such as the date of transaction and the amount paid. If the cryptocurrency itself is bought or sold, the IRS considers the activity similar to the purchase and sale of stock, and will expect individuals to keep a record of all their transactions — along with proof of the buy and sell prices and the dates of each individual transaction.
- Report transfers of digital currency. The IRS may soon take the position that the transfer of digital assets is a reportable transaction, and require a report of any capital gains or losses.
- Report payments made to employees, or currency received as a gift. Just as with government-backed currency, businesses are required to report all employee or contractor payments, and to pay employment and withholding tax where applicable. Those who are gifted digital currency must report it on their taxes, when they sell it, using the same cost basis as the person or entity who gave it to them.
As yet, this is a largely uncharted realm. But the tax climate around cryptocurrency and digital assets is rapidly changing. Tax authorities around the globe are currently developing methods to investigate and prosecute cryptocurrency tax crime and fraudulent activity involving digital assets. It is wise to keep in mind that the IRS may allege there is no time limit on the IRS auditing a person’s or business’s taxes for fraudulent cryptocurrency activity.
Tax attorney Steve Moskowitz founded what would become Moskowitz LLP more than 30 years ago, offering clients a full variety of services that include domestic, international and criminal tax law representation; tax planning; and tax preparation of current and delinquent fillings. Having practiced as a CPA before becoming a tax attorney and having worked at a “Big 8” (now “Big 4”) firm, as well as teaching tax, law and accounting at the nation’s most prestigious universities, Moskowitz has served as an expert legal analyst for top media outlets, where he appears daily on the radio and weekly on TV. His message is simple: Don’t go it alone against the IRS.