Cryptocurrency may be virtual money, but the IRS expects real taxes to be paid on this method of exchange.
When cryptocurrencies made their appearance more than a decade ago, there was a naive belief that they might, given how they work, escape taxation and regulation, much like believing before 1980 that average gas prices couldn’t surpass $1 a gallon because gas pumps didn’t go that high. What happened? New pumps were designed.
The IRS is designing new pumps for cryptocurrencies.
Three letters from the IRS were sent in July to cryptocurrency owners and traders; the first two required the recipients to do nothing if they had met their cryptocurrency-related tax obligations. The third was different: It said that the individual may have failed to report income; if they didn’t respond they would be audited.
More than 10,000 letters were received by the end of August, the recipients tabbed through IRS compliance work. However, as with audits, which touch only a small percentage of taxpayers, the letters likely aren’t reaching everyone who needs to know.
Consider the IRS letters as a two-pronged direct-and-indirect communications spear directed at cryptocurrency users and traders: If we’re not sending the message directly to you, you need to get the message we’re paying attention to people just like you.
No one should think this ends with three letters.
Cryptocurrency, according to Merriam-Webster, is: “any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.”
The virtual currency isn’t issued by governments, thus the “no central regulating authority” description. Estimates in June by Investopedia said more than 1,600 cryptocurrencies then existed, and there’s no regulating authority to suggest that number won’t substantially grow or shrink. The top five cryptocurrencies today, according to the bitdegree.org website, are: Bitcoin, Ethereum, Ripple, Bitcoin Cash and EOS.
Cryptocurrency has been, is now and will be an evolving issue and problem for taxpayers, tax professionals and tax collectors alike. It’s assigning a dollars-and-cents value to something that the IRS identifies as a “digital representation of value that functions as a medium of exchange.”
The IRS, for tax purposes, considers cryptocurrency as property. And it can be a high-value property. For example, through August, Bitcoin hovered just above $10,000. Total market capitalization for cryptocurrencies was around $285 billion, a hefty sum but below that of January 2018, when it surpassed $800 billion.
Though some of the luster may be rubbing off cryptocurrencies, the IRS smells taxes. More importantly, taxes not being paid. If cryptocurrency has been used as payment for a good or service, the taxpayer is required to compute the U.S. dollar fair market value as of the receipt date of the cryptocurrency that served as payment.
Cryptocurrency paid as wages to an employee is taxable income and subject to withholding, Federal Insurance Act (FICA) tax and unemployment taxes. Independent contractors are self-employed taxpayers; cryptocurrency qualifies as gross income and therefore taxes must be paid based on fair market value as of the receipt date.
More detailed information is contained in IRS Notice 2014-21.
The IRS is designing new ways to pump taxes from cryptocurrency into the public coffers. If you are in cryptocurrency, or thinking of getting into it either as a user or trader, the taxman cometh.
This article was originally published in the Knoxville News Sentinel.