Knowledge and Insights
In 2014, the Internal Revenue Service (IRS) issued limited guidance on cryptocurrency, which led to more questions than answers. As the use of digital currency has become more widespread in the last several years, the IRS has focused recent enforcement efforts on educating taxpayers, to help ensure they are compliant in reporting and disclosing their virtual currency transactions.
Cryptocurrency is most commonly defined as a digital asset, or a digital representation of value, that has been designed to function as a medium of exchange. This virtual currency operates similarly to the tangible real currency that we use on a day-to-day basis. It is not, however, issued by a central bank or a public authority, but it is controlled and traded electronically.
For tax purposes, virtual currency is treated as property and the general tax rules that apply to property transactions also apply to virtual currency transactions. Such transactions may produce taxable events and/or additional reporting requirements. Recently, the IRS issued further guidance on virtual currency transactions, including, but not limited to, the following:
- Gain or loss recognition from the sale or exchange of virtual currency;
- Gain or loss recognition when using virtual currency to make a payment;
- Receipt of virtual currency as payment for providing goods or services;
- How the fair market value of virtual currency is determined;
- How the tax basis of virtual currency is determined;
- Virtual currency payments made to independent contractors or employees.
New to tax year 2019, a question regarding cryptocurrency has been added to the Form 1040, Individual Income Tax Return. The question asks if “you received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency” during the year. Failure to properly report and disclose virtual currency transactions could result in IRS enforcement action. Taxpayers could be audited and liable for applicable penalties and interest. Under more extreme circumstances, taxpayers could even be subject to criminal prosecution.
With over 1,500 known virtual currencies available, details of transactions can be very cumbersome and difficult to track. It is important to maintain complete and accurate records of all virtual currency transactions. Such records should include details of fair market value, documentation of any transactions or exchanges, and the original cost to acquire the currency, including fees, commissions and other acquisition costs.
The professionals at The Mercadien Group can assist you in navigating the complexities of virtual currency and virtual currency transactions. Please contact me or your advisor in our Individual and Family Office Services Group at firstname.lastname@example.org or 609-689-9700 for additional information.