With the April 17 deadline for filing individual tax returns just around the corner, individuals who engaged in cryptocurrency transactions during 2017 must take care to properly report them on their tax returns. As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase recently announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And most recently, on March 23, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.
Four years ago, the IRS issued its only guidance to date regarding its view of the tax treatment of cryptocurrency transactions. Despite the explosion of interest in cryptocurrencies (currently more than 1,500 such currencies exist) and the monumental increase in Bitcoin’s value last year (an uptick of more than 1,400 percent before year’s end), the IRS has not updated its views or issued further guidance to investors, thus leaving individuals scrambling to make sure that their 2017 tax returns are properly capturing cryptocurrency transactions. This is especially critical for investors who sold Bitcoin during its rocket-like trajectory last year.
The IRS considers cryptocurrency transactions taxable just like transactions in any other property, and general tax principles that apply to property transactions apply. As a consequence, the following rules apply:
– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply. Normally, payers must issue Form 1099-MISC.
– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.
– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.
– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
In an article published by Bloomberg today, Lily Katz and Lynnley Browning write that many investors, and even tax professionals, are struggling to properly report their cryptocurrency transactions on their 2017 tax returns, due to be filed in four days:
If you thought trading Bitcoin was wild, try figuring out how to pay taxes on it.
Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year’s boom in values, many people are likely disclosing transactions for the first time, adding to confusion.
The Bloomberg article further reports that the IRS is advising individuals to look for tax guidance in analogous areas:
An IRS spokesman said that in addition to the agency’s 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the “factual scenarios that most closely resemble their circumstances.”
Individuals who fail to properly report their cryptocurrency transactions can face harsh consequences, including civil audits, penalties, and even criminal prosecution, as the IRS warned in a recent press release reminding taxpayers to report such transactions:
Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.
In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.
Despite the lack of up-to-date IRS guidance, and the uncertainly surrounding the tax consequences of recent developments in this area (such as “hard forks”), cryptocurrency investors would be well-advised to exercise caution with their income tax returns due next week.