Cryptocurrency has become not only a popular topic of conversation but also the source of a number of tax-related inquiries. Near the end of the year, the rapid rise in the trading value of Bitcoin created increased interest in the cryptocurrency. Venezuela, recently, rolled out their own national cryptocurrency to try to remedy that nation’s economic woes.
With the additional national and international awareness of cryptocurrencies come a number of questions. Some of those, such as how a cryptocurrency works and what it’s backed by, are beyond the scope of this blog, but the taxation of these digital assets is worth discussing.
There are three main areas where cryptocurrency is involved in transactions: purchasing goods and services, selling goods and services, and investing. We will look at all three of those areas.
Receiving Payment in Cryptocurrency
Receiving a payment in cryptocurrency is treated, from a tax perspective, the same way as receiving cash. For example, an online sale of a good for $500 in U.S. dollars would be includable in income. Selling that same good online in exchange for 1/10 of a Bitcoin would also be includable in income. The challenging part is converting the value of the cryptocurrency into U.S. dollars.
Virtual currencies that are listed on an exchange and/or that have an exchange rate that is publicly available make translating the value of the currency into U.S. dollars much easier. For instance, if Bitcoin is trading at $8,000, that 1/10 of a Bitcoin is worth $800 and is includable as income at $800. Because of the volatility in the exchange rates and values of cryptocurrency, companies conducting business transactions with cryptocurrency should be aware of the fair market value of the currency at the time each transaction occurs.
Making Payments in Cryptocurrency
Similar to receiving payment in a virtual currency, paying a person or entity in a cryptocurrency does not alleviate a taxpayer from his or her typical responsibilities. For instance, paying an unincorporated subcontractor in a cryptocurrency will potentially be subject to 1099 filing, assuming that the fair market value of the payments, when converted to U.S. dollars, is greater than $600 for the year.
Paying employees in cryptocurrency, while probably a rare occurrence for most businesses, constitutes wages that are includable on a W-2 and subject to the standard withholdings, including backup withholding as applicable.
The most common transaction regarding cryptocurrency is the active investing and trading of the asset. When Bitcoin prices were increasing dramatically, some prognosticators suggested that the value of one Bitcoin could go as high as six figures. Anyone investing in virtual currencies will be subject to tax (likely capital gains tax) upon the sale of those currencies.
For cryptocurrencies that are traded on an active market, gains and losses on the sale of the assets will potentially be included on a year-end 1099 from a brokerage. However, the lack of regulation of many cryptocurrencies means that taxpayers are on their honor to report gains and losses from the purchase and sale of cryptocurrencies because there is no brokerage with data on the purchase and sales price of the digital assets. Anyone that invests in cryptocurrencies should be keeping a record of the amount that they purchased them so that they are accurately reporting gains and losses upon the disposal of the cryptocurrency.
By Dan Massey, CPA, Principal