Crypto & Bitcoin Income Tax Filing: Cryptocurrency tax enforcement has become a key compliance priority for the IRS. While the tax rules continue to evolve, the past few years have proven that the Internal Revenue Service seeks to aggressively seek enforcement. In 2019, the IRS issued a revenue ruling (RR 2019-24) on the treatment of crypto. Despite the revenue ruling, many questions remain unanswered about how crypto income and reporting is treated — especially if it involves overseas and international cryptocurrency. Moreover, the draft version of the 2020 1040 tax return has a direct question regarding virtual currency (aka crypto or Bitcoin) on the very first page of the tax return. That should give you a clear indication of how cryptocurrency has become a key enforcement priority for the US government.
A few other facts to keep in mind:
- In 2018, the courts approved a version of the summons that was sent to Coinbase to obtain client information.
- The United States became a member of J5 in which one of the key priorities is to enforce international cryptocurrency tax compliance.
- The IRS is again issuing letter 6173 and 6174 to Taxpayers in order to further enforce cryptocurrency compliance (these are considered soft letters and while they are not a direct notice of audit — they can lead to further follow-up if the matter is not resolved).
Common Crypto/Bitcoin Questions & Answers
One of the biggest issues with cryptocurrency, Bitcoin, etc. is determining how to treat it for US tax and reporting purposes.
Let’s work through 25 of the most commonly asked questions regarding virtual currency (noting, the rules are still evolving and you should always be sure to check any recent updates):
1. Is Crypto Treated as Currency or Property?
Cryptocurrency is considered property, not currency, for US tax purposes. Therefore, the taxation of cryptocurrency exchanges will be treated differently than if it was currency.
2. Tax Treatment of Property vs Currency?
Here is a simple example of the difference between property versus currency for tax treatment:
If Peter goes to the store with $100 and purchases something for $95, the transaction is relatively simple. Peter gives the clerk $100 and receives the product as well as $5 back. The product is worth $95 and that will be the adjusted basis (aka the original cost) for the product.
Instead, if Peter has crypto worth $10,000 that he exchanges for a new crypto valued at $10,500, then Peter has a $500 gain. In other words, Peter exchanged an asset that was worth $10,000 and received another asset worth $10,500. That new asset in Peter’s hand is worth $10,500. Presuming it was an arms-length transaction, the general rule would be Peter has a $500 gain that he would need to report on his tax return for the current year. When Peter goes to sell or transfer the new asset, it will be worth $10,500.
As you can imagine, when a person has hundreds, thousands, or even millions of crypto exchanges in a single year — the tax ramifications can be daunting.
3. What is the Crypto Question on the new 1040?
As we mentioned in the beginning of this article, the draft version of the new 1040 has a specific question regarding the ownership, sale, exchange, etc of virtual currency. The draft 1040’s crypto question is: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?“
4. Is Crypto Reported on the Tax Return?
Yes. If your cryptocurrency was sold or exchanged, it is generally reported on Schedule D while incorporating form 8949 to identify each transaction.
If instead the crypto was received for employment purposes, then it would be reported as income.
In other words, the crypto is reported based on the category of income represented by the crypto transaction.
5. Do I Report Each Crypto Sale or Exchange Transaction?
Yes. Technically each transaction involving cryptocurrency (unless it was only purchased and not sold or otherwise exchanged) is reportable on the tax return.
For example, if Melissa purchased cryptocurrency for $25,000 but did NOT sell or exchange that cryptocurrency — the mere purchase of the crypto is not in and of itself a reportable transaction.
6. How do I Report Each Transaction?
Each transaction is reported on Form 8949, which is a form that accompanies Schedule D.
7. What if I Exchange Crypto for Crypto?
When a person exchanges cryptocurrency for different cryptocurrency, this is an exchange of assets between two parties and it is reportable on Schedule D. Since 2017/2018 (and probably before that as well), the 1031 rules do not apply.
8. What if I Exchange Crypto for Other Property?
It is still reportable. When a person exchanges cryptocurrency for other property, that too may result in a capital gain or loss which is reportable on Schedule D as well.
9. What if I Exchange Crypto for Services?
When a person receives cryptocurrency for services, it is reportable as well — but it would not usually be reported on Schedule D; rather, it is booked as regular income.
For example, Denise’s employer pays Denise in cryptocurrency for the work she performed. Denise reports that cryptocurrency as income and pay all necessary employment and related taxes.
Likewise, the value or adjusted basis of the cryptocurrency in Denise’s hand will be the value she reported as income.
So, if Denise was paid $100,000 in cryptocurrency for the work she performed and next year, she sells that cryptocurrency for $110,000 — she would have a $10,000 gain.
10. What About Cryptocurrency Investments?
Cryptocurrency investments can get very complicated.
The baseline perspective is this: if your cryptocurrency is bundled in a fund or other investment and it generates income — it may be taxable.
Generally, earned investment income to U.S. persons is taxable when it accrues, but there are some exceptions depending on whether the taxpayer has the opportunity to select a cash vs reinvestment dividend.
11. What if the Crypto Generates Income?
If cryptocurrency is in an account or other exchange that generates any type of income, then the income may be taxable.
12. What About Drop-Ins?
Drop-ins are generally taxable and will usually have a zero basis since they were “dropped into” the account and not purchased or exchanged.
13. What About a Hard Fork?
The hard fork is similar to a stock split. Unless there are drop-ins that accompany the fork, a hard fork is not in and of itself a taxable event.
The main result of a hard fork will be the single blockchain is turned into two block chains.
14. What About a Soft Fork?
Similar to the hard fork, the soft fork is not generally taxable either. With a soft fork, the old version of the blockchain is updated with a new version or modification — but it does not result in two block chains.
15. What About Mining for Crytpocurrency?
Mining is the concept of researching transactions and updating public records — with the hope of receiving crypto as a result of the hard work performed — similar to mining for gold.
It may start out as a hobby but if income begins to generate, then it is generally going to be taxable at the time it is sold or exchanged.
16. What is the 6173 Letter?
The 6173 letter is an IRS letter involving cryptocurrency. It basically says that the IRS has information that the Taxpayer may not have met their US tax filing and reporting requirements.
It requires the Taxpayer to make a timely response to the IRS. But, while the letter may be scary, it is important to remember that it is not an actual audit per se.
17. What is the 6174 Letter?
IRS letter 6174 is a little different. It also involves cryptocurrency, but it does not indicate that the Taxpayer has made any mistake. Rather, it is a rather a reminder to the Taxpayer that they may be non-compliant and should review their virtual currency transactions.
18. What is the 6174-A Letter?
The IRS Letter 6174-A is similar to the 6174 letter, with the main difference being that it expressly states at the end of the letter that the recipient does not need to respond to the letter.
19. What is the Coinbase Summons I keep hearing about?
Coinbase is one of the largest international cryptocurrency exchanges.
A few years back, the IRS sought to issue a summons against Coinbase. Coinbase fought the summons but at the end relented and provided information for more than 13,000 account holders to the Internal Revenue Service.
20. What About Crypto Tax Audits?
Cryptocurrency tax audits are on the rise. In recent years, the IRS has made cryptocurrency tax enforcement a key priority, and therefore taxpayers with cryptocurrency should remain compliant. That way if they are audited, they can reduce or eliminate any taxes and penalties that would otherwise be required for previous noncompliance.
21. Do I Need to Report Foreign Crypto on Schedule B?
When it comes to international cryptocurrency, the IRS has not provided clear-cut guidance on what Taxpayers have to report.
In general, if a person has foreign accounts that hold cryptocurrency in those accounts, then the taxpayer may consider identifying that they have ownership or signature authority over a foreign account on question 7, schedule B (this is different than reporting interest or dividends generated from cryptocurrency investments).
22. Do I Need to Report Crypto on the FBAR (FinCEN Form 114)?
The FBAR is a controversial form used to report foreign bank and financial accounts and carries a hefty penalty for account holder noncompliance.
While the form is actually a FinCEN form and not an IRS tax form — it is enforced by the IRS.
Whether or not cryptocurrency must be reported on the FBAR depends on a myriad of different factors. We have an entirely different FBAR crypto summary you can refer to in order to evaluate your overseas crypto and determine whether reporting would be applicable.
23. Do I Need to Report Crypto on FATCA Form 8938?
Foreign cryptocurrency may also have to be reported on IRS form 8938 in accordance with FATCA (Foreign Account Tax Compliance Act). Form 8938 requires the Taxpayer to report specified foreign financial assets to the IRS.
If the cryptocurrency is being maintained in a foreign financial institution, then there is a likelihood that it may be required to be disclosed on Form 8938.
24. Do I Need to Report Crypto on Form 8621 (PFIC issues)?
If your foreign cryptocurrency is held in a Passive Foreign Investment Company, such as a holding company, fund, or other bundled security, it may be considered a PFIC.
Form 8621 is used to report PFIC and it is a very complicated form. We have additional PFIC resources to assist you with understanding whether your cryptocurrency may be considered PFIC.
25. What if I have Unreported Crypto; is there IRS Amnesty?
The Internal Revenue Service has significantly ramped up enforcement of cryptocurrency. If you are out of compliance for prior year reporting in tax our domestic or offshore cryptocurrency, you may be able to get into compliance with one of the approved offshore tax amnesty programs.
As recently as 2019, the IRS stated that there would not be a separate offshore tax amnesty program for cryptocurrency, but that may change in the future.