Virtual currency is an alternative payment method that made its appearance on the financial scene in 2008. It includes cryptocurrency (like Bitcoin), non-fungible tokens (NFTs), and many other types of digital assets.
By definition, virtual currencies (a.k.a. digital assets or currencies) are digital representations of value recorded on a cryptographically secure and distributed ledger. In a nutshell, super secret codes make virtual valuables safe; distributed ledgers make them trustworthy.
Virtual currency has attractive benefits.
- It’s cashless.
- In the beginning, it cut out the middle-man (banks).
- It is highly secure, making it the most hack- and forgery-proof payment system.
- It is anonymous.
- It makes conducting international business easier.
One more benefit made it especially attractive– traders and investors in digital currencies avoided taxes for a time at its inception.
The IRS’s Role
People began taking advantage of loopholes created by virtual exchanges to evade taxes, launder money, and defraud victims. It wasn’t long before the IRS caught on and did something about it. Virtual currency now has tax implications at all levels: state, federal, and international.
The tax regulations aren’t always straightforward. For starters, tax treatments vary, making reporting complex. Calculations and processes require deciphering and judgment calls by a trained eye.
As a business owner, educating yourself on virtual currency before accepting or rejecting it as payment from your customers is critical. A knowledgeable, tax accounting firm can help you account for digital assets, whether you invested in them or traded them for business purposes.
CPAs are your best bet for getting your taxes right and staying out of the IRS’s crosshairs. Our Charlotte CPA firm can help. In this blog, we’ll answer some important questions and ask that you help us answer some. Here’s what you should know to help us better serve you.
Establishing the Basis
Your virtual currency has a cost basis, also known as its purchase price, adjusted basis, or just “basis.” Use the following calculation to arrive at yours.
Amount paid for the digital asset
+ Transaction Fees
+ Any additional costs
Basis (in US $)
You and your CPA must know this number. Using the basis, we determine losses or gains in value after you have sold, exchanged, or traded any type of digital asset and calculate any taxes you may owe.
Understanding the Tax Implications
You and your CPA must understand how and why you procured virtual currency and/or disposed of it. If you file any type of 1040 at tax time, your tax preparer needs to record any digital asset received or disposed of. You may need a Form 8949 or 709 for asset disposal.
You must record any virtual asset received from your business as income on the W-2 wages portion of Form 1040. If you received it for services or inventory, you may need to list it on Schedule C.
- Was it gifted? If you received it as a gift, you’ll need to know the giver’s cost basis and gift taxes (if any). Additionally, you’ll need to record its fair market value.
- Did your gift lose its value? We look at the fair market value and the gifter’s cost basis at the time of receipt. The lesser of the two amounts determines your loss.
- Did you accept it as payment for a service or product? Whether you’re an employee or an independent contractor, it will count as ordinary income on your taxes. You must know its fair market value at the time you receive it. That value becomes your cost basis. Contractors and employees report this on their W-2 if for amounts exceeding $600.
- Did you pay for goods or services using virtual currency? If you exchanged it for property or goods, you’ll record a capital gain or loss on your taxes. It will equal the difference between its fair market value when you received it and the cost basis when you exchanged it. You must record its fair market value at the time of exchange.
- Do you mine virtual currency, or are you a keeper of blockchain? Your job pays in virtual assets. Your earnings are subject to income tax guidelines. However, your tax accountant might be able to find tax deductions due to your at-home job’s use of electricity and computer power.
In short, if you’re paid by virtual currency, that is income. You are taxed according to federal income tax guidelines.
- Are you a virtual currency broker? New broker reporting rules are on the horizon.
- What about a charitable deduction for donated crypto? Charitable contributions in virtual currencies first require an appraisal value. Unfortunately, its value on the exchange doesn’t count as an appraisal. See your tax advisor first.
- What about deducting the loss incurred from worthless or abandoned virtual assets? It’s unlikely you have a worthless or abandoned virtual asset. It has value and is tradable if it’s still on the exchange.
Federal Reporting Rules
Virtual currencies trade on exchanges, much like stocks on the stock market. For now, exchanges don’t have to send tax forms to their customer base. Some send a 1099 or 1099-K to customers with over 200 transactions or totally $20,000. Others send nothing at all.
Regardless of what exchanges do or do not do, the IRS requires you to report all digital asset transactions.
State Reporting Rules
Calculating state tax adds another layer of complexity to taxing virtual currency– sales tax. Some states, like nearby Kentucky, treat it as equivalent to cash and tax it by the same standards. Other states (like NC) currently have no say on the subject.
International Reporting Rules
Anyone subject to US tax laws must file a Foreign Bank Account Report (FBAR) for any financial account outside the US if the value exceeds $10,000 at any point during the year. You do not need an FBAR if your foreign account contains only virtual assets. However, expect that rule to change.
Virtual Currency Best Practices
1. Document Everything
Documentation is essential. You must know your virtual asset values in US dollars at the time of the transaction.
Log everything regarding virtual assets. Maintain detailed records on the dates received and the fair market value at the time of receipt. Document the purpose– was it for payment, investment, or inventory?
Store each purchase in a separate online wallet if you have multiple transactions. Record the date you established the wallet, too.
Thankfully, technology can make tracking and recording virtual transactions easier. Invest in digital-friendly software to better manage your tax returns with less risk.
2. Hire a Tax and Accounting Firm
Accounting for and preparing tax filing for virtual currency can get complicated. Hire a professional accounting and tax firm to help you make the most of your business decisions and avoid unnecessary penalties or IRS attention year-round.
Help us leave no stone unturned. Tell us about virtual assets and document everything concerning your business and money.
