Taxing Issues Related to Cryptocurrency

Written by Jay LogalThe IRS has made cryptocurrency (bitcoin) a hot button topic. They recognize that taxpayers are not reporting transactions involving bitcoin, and they are taking steps to stop the under reporting of these transactions. The IRS has added a question on the 2019 income tax return that asks if you own any cryptocurrency. It’s important to let your tax advisor know if you have received or sold bitcoin during the year.Owning cryptocurrency (i.e. Bitcoin) could become a taxing nightmare. Buying, selling, or accepting cryptocurrency creates a taxable event. Buying cryptocurrency is much like buying stock in that it creates basis in an asset. The digital currency is an asset and, if sold, has a gain or loss. Like stock, the gain or loss is long term or short term depending upon how long you hold the currency.If you accept cryptocurrency in your business, the basis in the bitcoin is the amount of income recorded for services rendered, this is ordinary income. When you sell this bitcoin later, the capital gain or loss recognized is the difference between your basis and the selling price of the bitcoin. So, two taxable events occur, the recognizing of ordinary income when the bitcoin is received for services and the capital gain or loss recognized when the bitcoin is sold. The real danger in holding cryptocurrency happens when you receive a new cryptocurrency based on a percentage or dollar amount of the existing bitcoin owned. This type of transaction is known as a “hard fork.” Once the recipient can dispose of the new currency (the “airdrop” date) the FMV of the new currency becomes ordinary income to the recipient.As an example, if the FMV of the new currency you receive on the airdrop date is $100,000, you have ordinary income of $100,000 taxed in the year of the airdrop or transfer and the basis would be $100,000. This could create phantom income if the new currency is not sold in the year that it’s transferred, because no money is received until the currency is sold. The federal tax on this income could easily be in excess of $25,000 (state income tax could add to this). New cryptocurrency often starts very high when issued and quickly crashes. If the value of the new currency goes down in value, it could create capital losses which are limited to offsetting capital gains or a limit of $3,000 capital loss deduction. The result is that you will have to come up with money to pay tax on money you don’t have.Due to the complex nature of the tax laws surrounding cryptocurrency we recommend contacting your tax advisor anytime you receive bitcoin for payment for services or any other transactions involving bitcoin. Below is the link to the IRS FAQ on cryptocurrency (bitcoin).https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions