Bitcoin prices are booming along with most other crypto-currencies. If you own or trade Bitcoin. you are likely sitting on profits. Today I’m going to talk about how and why you should pay taxes on your Bitcoin profits.
What is Bitcoin?
If you don’t already know, Bitcoin is a digital or virtual currency created in 2009 by the mysterious Satoshi Nakamoto. It offers lower transaction fees, the anonymity of transactions, and is operated outside of government authority. Think of it as an innovative payment network and a new kind of money. You can learn more about it at www.bitcoin.org
If you’ve been investing in Bitcoin or other cryptocurrencies. Pat yourself on the back because you have likely profited nicely. In the United States, the Internal Revenue Service has issued guidance on virtual currencies so pay attention.
If you’re thinking that the IRS will never find about your Bitcoin transactions, after all, the transactions are supposed to be anonymous and outside of the government reach. Right?
Guess again. The IRS is actively investigating unreported transactions ie. tax evasion related to Bitcoin. They have subpoenaed the records of Coinbase, the most popular and mainstream Bitcoin platform in the US.
Heed my warning, pay your taxes. Their investigation could eventually lead to you owing back taxes or penalties, and even the seizure of your accounts.
Bitcoin and taxes is a hugely complex subject, so I’m only going to cover some basic examples.
Let’s say you bought 1 Bitcoin in 2015 for $200. Since then the price has skyrocketed. So now it’s 2017 and you sold your Bitcoin for $4000. You now have a realized long-term gain of $3800.
The IRS treats Bitcoin as property like stock investments and as such. The long-term gains are taxed at 15%. So in this example, you would have a tax liability of $570. This would be reported on Form 8949 of your personal tax return.
If you held the Bitcoin investment for less than a year, then the applicable tax rate would be at your highest ordinary income tax rate which is as high as 39.6%. But for most people, it’s 25 or 28 percent.
That’s easy enough. Here is where it gets complicated…
Let’s use the same example earlier but now you used the 1 Bitcoin to pay for some new hardwood floors in your living room. This is actually 2 transactions; disposing of the virtual currency and spending the virtual currency.
You will still have a $3,800 long-term capital gain. But now the recipient of the 1 Bitcoin has the responsibility to report the $4,000 as income on their tax return.
If you’re an active trader in Bitcoin, don’t expect a detailed 1099 listing your cost basis and gains and losses. It can be difficult but it’s important to keep good financial records. The burden of proof is on you, the taxpayer.
Can you donate Bitcoin and take the fair market value tax deduction?
Yes, but in order to take the full fair market value of the Bitcoin as a contribution. You must have held it for more than one year and keep in mind that gross income limitations apply. You also want to give or transfer the Bitcoin directly to the charitable organization. Otherwise, it is not as favorable from a tax standpoint.
What about business transactions with Bitcoin?
Business transactions in bitcoin are subject to all the normal rules for business transactions like sales taxes. Withholding and information reporting. In other words. If you use Bitcoin to pay for goods or services. You have two transactions. One is the gain or loss on the sale of Bitcoin. And the other is the transaction with paying for the goods or services.
If you use Bitcoin to pay your employees. All the same rules apply. You need to record the disposition of the Bitcoin, and all payroll related taxes, withholdings, and deposits need to be done as usual. Form 1099 information reporting is required as well when paying independent contractors in the course of business more than $600 in Bitcoin. It’s a reportable transaction by issuing a Form 1099 to the recipient at the end of the year.
How about lost or stolen Bitcoins?
It’s unfortunate but it happens. In a virtual world, hackers are kings. Lost or stolen Bitcoin would generally fall under Section 165 of the tax code. Casualty and theft losses. Yes, you can take a deduction for losses. But individual losses are subject to a $100 floor and are only deductible to the extent there is a total loss for the year that exceeds 10% of your adjusted gross income.
Red flag warning. Don’t even think about taking a loss deduction if you are not reporting your Bitcoin profits.
I hope that I’ve given you enough reasons why you should report your Bitcoin profits but here is another one. Often times you might need to produce a tax return for getting a loan on a home or for a business. The additional income from your Bitcoin profits may be essential in proving additional sources of income. It’s just another added benefit of paying taxes on your bitcoin profits.
The topic of Bitcoin and taxes is very complicated. If you are a Bitcoin user I urge you to pay close attention and don’t think for a minute the IRS will never find out. They may be playing catch up with technology but they are paying close attention. In addition, you can be subject to penalties for failure to comply with tax laws. Information reporting penalties. Tax evasion and tax fraud.
In closing, keep in mind that every Bitcoin or cryptocurrency transaction is a taxable transaction. If you need help with an issue related to Bitcoin or other virtual currency. Contact me.
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Disclaimer: Any accounting, business or tax advice contained in this article, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, I would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.
