Virtual Currency Investors have a lot of responsibilities!

by Foodman CPAs & Advisors
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For U.S. Federal Income Tax purposes, Virtual Currency (VC) is treated as property.  As a result, a VC investor ought to keep a very close watch on potential net short term capital gains (realized gain if VC is held one year or less) or long -term capital gains (realized gain if VC is held for more than a year). Net short-term capital gains are treated like ordinary income for tax purposes and taxed at the Taxpayer’s highest marginal federal income tax bracket. If a VC investor experiences a loss, net capital loses are capped at $3,000 a year. 

IRS guidance about the tax treatment of VC is limited.  IRS has issued Notice 2014-21 as a means to answer Frequently Asked Questions (FAQs) on VC.  The highlights of Notice 2014-21 are:

  • VC is not treated as a currency.  It is considered personal property and taxed as a capital asset.
  • If VC is converted into currency and there is a gain, it is subject to capital gain.
  • If goods or services are purchased with VC, the Taxpayer must also account for the gains.
  • A Taxpayer that receives VC as payment for goods or services must include the fair market value of the digital currency received measured in USD in the gross income on the date of the receipt. 
  • VC that is held and then sold at a gain is subject to either long- or short-term capital gains tax.
  • A Taxpayer, who holds VC for sale in a trade or business, is subject to ordinary gain or loss upon sale.
  • VC is recognized income immediately at the fair market value.  This income could be subject to self-employment tax.
  • Payments made using VC are subject to backup withholding to the same extent as other payments made in property. 
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
  • A person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services is required to report that payment to the IRS and to the payee on Form 1099-MISC, Miscellaneous Income.
  • The payment recipient may have income even if the recipient does not receive a Form 1099-MISC.

IRS has stated that VC transactions are underreported.  In the US vs Coinbase (Case No.17-cv-01431-JSC), IRS summoned Coinbase based on IRS’s research that “only 800 to 900 persons electronically filed Form 8949” to report VC sales.  Form 8949 is the IRS Form to report Sales and Other Dispositions of Capital Assets.  The IRS summons targeted 8.9 million transactions and 14,355 account holders.  The purpose of the summons was to investigate a “reporting gap between the number of virtual currency users Coinbase claims to have had during the summons period” and “U.S. bitcoin users reporting gains or losses to the IRS during the summoned years.” 

The net result of the US vs. Coinbase was that Coinbase was: “ORDERED to produce the following documents for accounts with at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013 to 2015 period:

(1) the taxpayer ID number,

(2) name,

(3) birth date,

(3) address,

(4) records of account activity including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and

(5) all periodic statements of account or invoices (or the equivalent)”.

On February 23rd, 2018, Coinbase notified approximately 13,000 customers that the court ordered Coinbase to provide taxpayer ID, name, birth date, address, and historical transaction records for certain higher-transacting customers during the 2013-2015 period.  The notification also encouraged the customers to seek legal advice from an attorney promptly if they have concerns, and that Coinbase expected to produce the information covered by the court’s order within 21 days. 

Take Away

VC transactions are not exempt from Government regulation and reporting.  The IRS is determined to audit the VC sector and close out or narrow the Reporting Gap.  IRS has demonstrated its determination via the Coinbase summons. 

Don’t be a victim of your own making.  If you are a Taxpayer with reportable gains, consult with your tax specialist, even if you have not received a Form 1099.  The burden is on the Taxpayer to report voluntarily and pay taxes on gains earned.  Taxpayers also ought to implement sound record keeping tracking their capital gains and losses.

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Foodman CPAs & Advisors
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