How will your investment in Cryptocurrency affect you at tax time?
November 10, 2021
Investment in cryptocurrency has soared in popularity in recent years. If you own, invest in, or use virtual, digital, or crypto currencies like bitcoin or Ethereum, it’s important that you maintain accurate records and take some time to understand how this may affect your income taxes.
Page one of the Form 1040 asks "...did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?" The bipartisan infrastructure bill, which President Biden is expected to sign the week of November 15th, expands the reporting requirements available to cryptocurrency, and is expected to generate revenue to offset new spending in the bill.
How is Cryptocurrency treated on your taxes?
The IRS treats cryptocurrencies as property, rather than currency. This means that anytime you use digital currency to buy goods or services, or you convert digital currency into a legal currency like dollars or yen, you may have gain or loss that must be included in your income.
Calculating Gains and Losses
To figure your gain or loss, you’ll have to show your basis in the currency. Basis is usually how much you paid for the currency. If you received the currency as payment for goods or services, your basis is generally the fair market value of the currency when you received it. If you received the currency as a gift or inheritance, contact us so we can assist you in determining how this will affect your situation.
Your gain or loss is the difference between your basis and the fair market value of the currency when you spend or convert it. If that fair market value is more than your basis, you have gain; it it’s less, you have loss. You must also determine whether you gain or loss is capital or ordinary. This depends on why you acquired the currency and how long you held it.
Cryptocurrency and Employment
Virtual currency can also affect employment income and taxes. Employees and independent contractors who are paid with virtual currency have income equal to the fair market value of the currency when it is received. If you “mine” the currency, you also have income equal to the fair market value of the currency when you receive it. If the mining activity is your trade or business, you’ll owe self-employment tax on the income. If you use virtual currency to pay employees or independent contractors, you may have to file information returns.
As you can see, using and owning cryptocurrency can complicate your tax situation. The IRS has set up a Frequently Asked Questions page all about cryptocurrencies, and proper planning now may be key to avoiding additional taxes and penalties in the future. Contact us today to schedule a planning appointment with your CPA!