April 14, 2021
Got Bitcoin? 3 Things to Know About Virtual Currencies and Filing Your 2020 US Tax Return
You may have noticed the seemingly new income tax return question on your Form 1040: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”.
Beginning on 2019 income tax returns, filers were required to answer “YES” to the question above if they had engaged in any transaction involving cryptocurrency.
Why? Because virtual currency is treated as property and a taxpayer is required to realize a capital gain or loss on the sale or exchange of owned property. This means engagement with virtual or cryptocurrency through selling, buying, receiving, earning interest, and paying for goods and services may result in tax liability.
However, not all transactions are created equal, nor are they taxed equally. We have broken down what you should be aware of when factoring virtual currencies into your 2020 US tax return.
1. Paying Taxes on Virtual Currency Capital Gains (or Losses!)
Did you know that buying that Louis Vuitton purse with Bitcoin could result in a capital gains tax? If you sold, exchanged, or transferred any virtual currency, you will need to use Form 8949 to find out your total capital gain (or loss!) for tax purposes. Once you have the total capital gain or loss, report it in Schedule D (on the tax Form 1040).
The difference between what you paid for the virtual currency in cash, services, or property and the amount you received in exchange (the value of a Louis Vuitton purse), is reported on your federal income tax return in USD.
Your tax rate depends on how long you held the currency and which tax bracket you fall into for the year. (Long-term capital gains are taxed at 0%, 15%, or 20%, and short-term capital gains are taxed at your marginal tax rate). If you are a higher-income taxpayer, you may be subject to 3.8% Net Investment Income Tax.
Holding the cryptocurrency for one year or more generates a long-term capital gain or loss, a holding period of fewer than 12 months is short-term gain or loss. The holding period begins on the day after you acquire the virtual currency and ends on the day you sell or exchange the virtual currency.
Capital losses are limited to $3,000 per year in excess of capital gains and losses can be carried forward in future years.
2. Is Your Virtual Currency Ordinary Income or a Capital Asset?
Virtual currency from your employer is considered ordinary income.
In this case, the income would need to be reported on your W-2 as wages (federal, state, and social taxes apply). The amount of income your employer should report is the Fair Market Value (FMV) of the virtual currency in USD. Note that taxes are required to be withheld on this income.
Virtual currency by way of payment for goods or services is classified as ordinary income.
If you file as a sole proprietor, independent contractor, or partnership, your cryptocurrency income will be reported on your income tax Schedule C and self-employment taxes are due. The amount of income reported is the FMV of the cryptocurrency in USD.
Although, if you have a crypto mining operation and your “mining” activity is not performed as an employee of another company, this is self-employment income. You can deduct mining costs from your self-employment income in this scenario. Self-employment tax on net income would still apply.
Virtual currencies via airdrop, hard fork, or gifts will need a closer look.
If you have income from crypto mining and staking, hard forks and airdrops, and crypto lending interest, this might be considered other income reported as additional income and adjustments to income.
Airdropping virtual currencies is like a cash giveaway treated as winning the lottery and therefore considered ordinary income. It is taxable on the date of receipt, at FMV, and in USD.
If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, or some other kind of transfer, you do not have taxable income. However, if a hard fork is followed by an airdrop and you receive new cryptocurrencies, you will have taxable income in the tax year when you received the cryptocurrency.
One good thing to note is if you receive virtual currency as a bona fide gift, it does not need to be recognized on your tax return until you sell, exchange, or otherwise dispose of that virtual currency.
How Virtual Currency Transitions From Ordinary Income Into a Capital Asset
Once you have paid tax on virtual currencies reported as ordinary income, the cryptocurrency becomes a capital asset. The basis of the cryptocurrency you receive as payment for goods or services is the fair market value of the virtual currency in USD as of the date of receipt. If sold or used to buy goods any additional gain is considered a capital gain.
3. Keep Careful Records on Each of Your Virtual Currencies
With PayPal allowing purchases to be made with Bitcoin, now you will need to keep careful track of your transactions. For tax purposes, you will need to show each transaction that occurred during the tax year in question.
It might be difficult to keep track of these details later on if you are not properly prepared to report transactions. The Internal Revenue Service (IRS) needs to know the currency name, number of shares, and the date/ time / FMV of when it was acquired and sold (plus each time it was sold or exchanged in between).
We recommend capturing this information through the First in First Out (FIFO) method, Actual Sales Method (ASM), Last in First Out (LIFO) method, or any reasonable accounting approach you choose.
The IRS has recently been cracking down on unreported virtual or cryptocurrency transactions. Failing to report can result in penalties, interest, or in high-level cases – fraud or imprisonment. Recently, the IRS released these FAQs on virtual currencies: link.
If you need help reporting virtual currency on your 2020 tax return, feel free to reach out to the team at firstname.lastname@example.org. You can also check out: 5 Tax Tips for Filing Your US Tax Return in 2021 for more help on your taxes this year.
Kimberly Engstrom, CPA
Kimberly is a Senior Manager, joining the firm in 2006. In her role, she specializes in the coordination of global engagements, providing individual tax planning and compensation recommendations to meet the client’s strategic goals.
Kimberly is a Certified Public Accountant with over 25 years of experience. She received a Bachelor’s degree in Political Science from the University of California, Santa Barbara.
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