There are a multitude of ways that technology has turned our world upside down. One of the most recent examples is cryptocurrency. And it’s inevitable that as cryptocurrency gains more traction, it will gain more attention from the IRS. The Service already knows that many cryptocurrency owners are not reporting or paying taxes on their cryptocurrency transactions. In fact, the IRS recently issued warning letters to over 10,000 taxpayers it suspects might have an under-reporting problem. So, if you own cryptocurrency, please keep reading for important information.
What is Cryptocurrency?
Cryptocurrency is a form of digital money that is not controlled by any central authority. The first cryptocurrency created was Bitcoin, back in 2009. Since then, over 4,000 other cryptocurrencies have been created. Cryptocurrency can be digitally traded between users and can be purchased for, or exchanged into, US dollars, euros, and other real or virtual currencies.
The (Current) Tax Treatment of Cryptocurrency
One of the big issues surrounding cryptocurrency is how it is treated for tax purposes. The IRS says that it is property, which means that every time it is traded, sold or used as money in a transaction, it is treated much the same way as a stock transaction would be. In other words, the gain or loss over the amount of its original purchase cost must be determined and reported on the owner’s income tax return. That treatment applies every time it is sold or used as money in a transaction.
On the bright side, cryptocurrency is generally treated as a capital asset for most holders, so any gain is a capital gain. If the gain is held for more than a year and a day, any gain will be taxed at the more favorable long-term capital gains rates. If the cryptocurrency is being held as an investment and the sale results in a loss, then the loss may be deductible. Capital losses first offset capital gains during the year, and if a loss remains, taxpayers are allowed a $3,000 per year loss deduction against other income, with a carryover to the succeeding year(s) if the net loss exceeds $3,000.
When cryptocurrency is used as payment to an employee, the usual payroll withholding and reporting still apply, and if used to make payments to an independent contractor, 1099 form reporting is still required. If the individual receiving payment in cryptocurrency is subject to backup withholding, the payer is required to withhold the required amount. In all reporting and withholding instances, the amounts must be in US dollars.
The IRS Compliance Program
If you have received one of the 10,000 letters sent out by the IRS, do not ignore it! The IRS compiled this list of taxpayers that it feels has not been reporting their cryptocurrency transactions from various ongoing IRS compliance efforts. Here are the three types of letters that were sent out and what you should do if you received it:
- Letter 6173 – This requires a response, either by providing a statement to the IRS that you have already complied with the required reporting or by filing a return that reports your cryptocurrency transactions. For situations where you had already filed a return but had left off the cryptocurrency transactions, an amended return (Form 1040X) will need to be filed. If you ignore this letter, you may face a full-blown audit by the IRS and could be subject to penalties.
- Letter 6174 – This is a “soft notice” that does not require a response, and the IRS says it won’t be following up on it. However, the notice also warns that if you had cryptocurrency gains and failed to amend your return or continue to be noncompliant on future returns despite receiving the letter, you will be in hot water.
- Letter 6174-A – You’re not required to respond to this letter, but you do need to correct your prior returns in which cryptocurrency transactions have been omitted. The IRS warns of future enforcement action if you don’t amend your return(s) or file delinquent returns. After receiving the letter, you can’t use an excuse of not knowing the law for failing to report their cryptocurrency gains.
The IRS has announced that it will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits and criminal investigations.
Taxpayers who do not properly report the income tax consequences of virtual currency transactions are liable for the tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.
If you have received one of these IRS letters – or even if you haven’t had correspondence from the IRS but have unreported cryptocurrency transactions from past years – and need assistance, please contact Cray Kaiser. We’re here to help!
Please note that this blog is based on tax laws effective in October 2019, and may not contain later amendments. Please contact Cray Kaiser for most recent information.