Do you buy, sell or engage in transactions involving virtual currency? If you do business with virtual currency, it’s important to stay up to date with the latest tax developments. The strategic operating plan for 2023 through 2031 released by the IRS earlier this year, indicated the agency’s intention to ramp up enforcement related to digital assets. As the IRS increases their focus on virtual currency transactions, this article provides a summary of terminology, taxation, and reporting obligations.
What is a Virtual Asset?
The IRS defines a virtual asset as any virtual representation of value that’s recorded on a cryptographically secured distributed ledger or similar technology. The term includes:
- Convertible virtual currency (meaning it has an equivalent value in real currency or acts as a substitute for real currency) such as Bitcoin
- Stablecoins (a type of currency whose value is tied to the value of another asset, such as the U.S. dollar)
- Non-fungible tokens (NFTs)
According to the IRS, cryptocurrency is an example of a convertible virtual currency that can be used as a payment for goods and services, digitally traded between users and exchanged for or into real currencies or digital assets. Cryptocurrency uses cryptography to secure transactions that are digitally recorded on a distributed ledger (for example, blockchain).
Taxation of Transactions
For federal tax purposes, digital assets are treated as property. Thus, transactions involving virtual currency are subject to the same general tax rules that apply to property transactions, such as purchases and sales of stock or real estate.
Several types of virtual currency transactions can trigger reporting obligations, including:
Sales: If you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses. The gain or loss equals the difference between your adjusted tax basis in the currency and the amount you receive for it. You should report the amount you receive on your federal income tax return in U.S. dollars (see below for more information on reporting obligations).
Your basis is the amount you spent to acquire the virtual currency, including fees, commissions and other costs. Your adjusted basis is your basis increased by certain expenditures and reduced by certain deductions or credits.
Property Exchanges: If you exchange virtual currency that you hold as a capital asset for other property (including goods or other digital assets), you must recognize a capital gain or loss. The gain or loss is the difference between the fair market value (FMV) of the property you receive and your adjusted tax basis in the virtual currency. If, as part of an arm’s length transaction, you transfer a digital asset and receive other property in exchange, your tax basis in the property you receive is its FMV at the time of the exchange.
Payment for Services: If you receive virtual currency for performing services — regardless of whether you perform the services as an employee or an independent contractor — you recognize the FMV of the currency when received as ordinary income. The FMV will also be your tax basis in that asset.
Conversely, if you pay for a service using virtual currency that you hold as a capital asset, you’ve exchanged a capital asset for the service and will have a capital gain or loss. In addition, the FMV of virtual currency that’s paid as wages, at the date of receipt, is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax. It also must be reported on Form W-2, “Wage and Tax Statement.”
A new line on the 2022 individual federal income tax return asked the following:
“At any time during 2022, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”
If you answer “yes,” all related income, whether as income, a capital gain or loss, or otherwise (for example, as a gift) must be reported.
The Infrastructure Investment and Jobs Act (IIJA) expanded the definition of brokers that are required to report their customers’ gains and losses on the sale of securities during the tax year to the IRS on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” The form generally requires a description of each sale, the cost basis, the acquisition date and price, the sale date and price and the resulting short- or long-term gain or loss.
Under the IIJA, operators of trading platforms for digital assets, such as cryptocurrency exchanges, are subject to the same reporting requirements as traditional securities brokers. The effective date remains to be seen, though, as the IRS hasn’t yet issued final regulations with instructions. After the new rules take effect, cryptocurrency platforms will need to collect Form W-9, “Request for Taxpayer Identification Number and Certification,” from their customers.
The IIJA also amended existing anti-money laundering laws to treat digital assets as cash for purposes of those laws. As a result, beginning in 2023, businesses must report to the IRS when they receive more than $10,000 in digital assets in one transaction or multiple related transactions.
Such transactions should be reported on IRS Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business.” To complete the form, a business will need to gather the name, address and taxpayer identification number, among other information, from the payer. Failure to comply may lead to significant civil and criminal penalties.
The IRS may uncover digital assets through a John Doe summons. The U.S. Department of Justice notes that “because transactions in cryptocurrencies can be difficult to trace and have an inherently pseudo-anonymous aspect, taxpayers may be using them to hide taxable income from the IRS.” By asking a court to serve a John Doe summons on a crypto dealer or exchange, the IRS can extract information about a person’s account.
As virtual currency continues to evolve, we will likely see the IRS increase their focus on regulation and enforcement efforts. We will keep you updated on any changes to help you stay in compliance with all applicable rules and requirements. For more information about the IRS’ plan to tax nonfungible tokens (NFTs), please see our most recent article. If you have questions about cryptocurrency and how new laws may affect your taxes, please contact a member of the Janover team today.