Tax Clarification for Cryptocurrency Holders

The IRS received attention when it sent letters to thousands of taxpayers in August 2020 reminding them of cryptocurrency reporting requirements. That batch of letters was just one clue that the IRS is ramping up interest in bitcoin and other virtual currency. Sure enough, the first page of the updated 2020 Form 1040, Individual Income Tax Return, includes a question about acquiring “any financial interest in any currency”. 

Interestingly, the IRS recently clarified that taxpayers who use real currency to purchase cryptocurrency do not need to indicate that on Form 1040. In other words, if you simply purchased Bitcoin in 2020 and the amount you purchased is still sitting in your digital wallet, you should not have to inform the IRS. When do you need to check “yes” to the IRS’s question on virtual currency? When you: 

  • Receive cryptocurrency for services rendered
  • Sell cryptocurrency
  • Trade cryptocurrency on products or services

If you check “yes”, do not worry—you have not needlessly created a taxable event for yourself. If you sell cryptocurrency for a profit, you will need to report that on your tax return as a capital gain. Crypto that you held for more than a year will likely be regarded as long-term capital gains, which has a lower tax rate than short-term capital gains. Conversely, you might be able to deduct a capital loss if you sell cryptocurrency for less than you paid for it. 

When is Cryptocurrency Reported as Income? 

To put it simply, cryptocurrency is treated as income when you receive it as if it were income. After receiving cryptocurrency in exchange for services performed, you will need to calculate the fair market value of the virtual currency. That income is subject to federal withholding taxes, including FICA tax. The same principle applies to independent contractors. 

What are the Penalties for Not Reporting Cryptocurrency? 

Those who fail to report cryptocurrency transactions on the appropriate tax form can, in worst-case scenarios, be charged with tax evasion. Those convicted of this crime can face a fine of up to $250,000 and five years in jail. Apart from criminal charges, the IRS can always pursue civil actions against taxpayers who acted negligently. 

Besides property reporting all taxable events having to do with cryptocurrency, be sure to keep all records that justify positions you take on tax forms. Keep an organized database of records involving cryptocurrency sales and exchanges. 

Most importantly, hire a knowledgeable and experienced tax attorney if you so much as suspect that you will be audited. Your legal counsel will know how to communicate with IRS representatives and guide you through a stressful situation. Weisberg Kainen Mark has decades of combined experience helping taxpayers resolve disputes with the IRS, but our attorneys are up-to-date on the latest tax developments. Call us at (305) 374-5544 to schedule a consultation today. 

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