Bitcoin or crypto-currencies maybe virtual in form , but the tax event of virtual currencies are real ! Despite the huge claim about anonymity of the holder of bitcoins or crypto-currencies , IRS is very close to put in place the lid on any evasion that a person may plan to avoid paying taxes on bitcoin or taxes on ethereum transaction. IRS has taken position that any transaction in virtual currency -be it sale or exchange or barter -by any person in United States will have tax consequences .In other words , end to the question: is bitcoin.tax legit?
Coinbase Tax Case Ruling a Boost to IRS
Do you pay taxes on bitcoin gains ? This is serious question now on account of recent ruling by a federal court judge U.S. of District Court for the Northern District of California U.S. v. Coinbase 17-01431 that covers transactions between 2013 and 2015 compels San Francisco-based Coinbase to comply with a summons that requires it to identify accounts that conducted bitcoin transactions—either exchanging bitcoin for dollars, or sending or receiving coins from another bitcoin user—worth $20,000 or more. Estimated accounts affected are 14,355 rumored to have accounted for nearly 9 million transactions.
How IRS view Bitcoin for taxation purpose ?
IRS has issued public notice Notice 2014-21 in which it has declared to treat the virtual currency as property. So if you have a holding of virtual currency , it will be treated as any other investment and capital asset in your hand. On the nature of virtual currency , the notice put the question and answer as under :
Q-1: How is virtual currency treated for federal tax purposes?
A-1: For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.
Q-2: Is virtual currency treated as currency for purposes of determining whether a transaction results in foreign currency gain or loss under U.S. federal tax laws?
A-2: No. Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
Bitcoin Capital Gains
If you invest in bitcoin mining and hold the virtual currencies for investment purpose , any transfer , sale or exchange with another property may result in gain or loss depending upon the the fair market value of property received in exchange. If virtual currency value is less than the value of the property , difference will be your capital gain , if not it will be capital loss.
If you hold the virtual currency for more than one year before selling or transferring or exchanging , resultant gain or loss will be terms as long term gains or loss. IF held for less than 12 months, it is short term capital gains or loss.
The Tax Cuts & Jobs Act Effect on Virtual Currency
Section 1031(a)(1) of the US Code 26 provides exemption from tax when a property is exchanged for similar type property. For ready reference the provision of law is given below :
(a)Nonrecognition of gain or loss from exchanges solely in kind
No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment
So it was an arguable case that the if bitcoin (a property ) is exchanged for say Litecoin or Etherium , a person may argue that section 1031 applies to such exchange and gains are not taxable .
However , Sec. 13303 of the recently passed The Tax Cuts and Jobs Act ,amended IRC Section 1031 (a)(1) to delete the word “property” and replace it with “real property” … excerpt from final bill
SEC. 13303. LIKE-KIND EXCHANGES OF REAL PROPERTY. (a) In General.--Section 1031(a)(1) is amended by striking ``property'' each place it appears and inserting ``real property''.
This amendment therefore eliminates possibility of argument that when you exchange one virtual currency to another , it is not recognizable under section 1031 of US Code 26
Virtual Currency Accepted For Price of Goods or Services
If a person receives the virtual currency as a price for goods or services, IRS made it clear that in such case the recipient will have to enter Fair Market Value of the said currency in dollar terms on the date of receipt. IRS further clarified that if a virtual currency is listed on an exchange and the exchange rate is established by market supply and
demand, the fair market value of the virtual currency is determined by converting the virtual currency into U.S. dollars (or into another real currency which in turn can be converted into U.S. dollars) at the exchange rate, in a reasonable manner that is consistently applied.[ refer question 5 of notice 2014-21]
Mining of Bitcoins or Virtual Currency
When a taxpayer “mines” virtual currency , he/she is awarded with some virtual currency like bitcoins or others as reward. IRS has clarified that , the fair market value the virtual currency as of the date of receipt should be included in gross income of the person in the year of receipt.
The individual who “mines” virtual currency as a trade or business subject can regard the rewards of crypto-currenciess as self-employment income by deducting all expenses associated with the virtual currency mining activities. So the person can pay self employment tax on income out of mining of virtual currencies.
Salary or Wages in Virtual Currencies
If any organization pays employees or workers in virtual currencies, IRS has clarified that the fair market value on the date of receipt by the employee shall be counted for tax withholding and legal purpose. So , employer and employee will have to comply with Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2.
Reporting Requirements for Virtual Transactions
When a person who in the course of a trade or business makes a payment of $600 or more in a taxable year to an independent contractor for the performance of services , the payment is required to be reported is required to be reported on Form 1099- MISC, Miscellaneous Income. This law of reporting equally applicable when the payment is made in virtual currency. The fair market value of the virtual currency in U.S. dollars as of the date of payment will be taken for reporting purpose.
Read irs guidance on cryptocurrency – irs virtual currencies guide