Cryptocurrencies like bitcoin have become increasingly popular over the past few years. With the value of bitcoin growing, more and more investors have put their gaze on Bitcoin and other emerging cryptocurrency. One Bitcoin at the time of publishing sits around the $7,000 mark, but it was just a few months ago that it hit a record high in December 2017 at almost $20,000
If you are tempted to invest in or trade bitcoin, it is important that you remember to identify them on your tax returns, especially if earned any income. Otherwise, you might face penalties, interest, and potentially other issues from the IRS.
The 411 on Cryptocurrency
For those who don’t know, cryptocurrency is the term for digital or virtual currency, of which there are currently almost 150 different kinds. It has no issuing authority, such as a government, bank, or financial institution. Because it has no central authority, it theoretically remains immune to any manipulation or interference by a government or other authority.
Although it has no central backing, it uses cryptography for security, which makes it difficult to counterfeit. The most well-known cryptocurrency is Bitcoin, which began in 2009. The rise in value has led to crypto trading becoming a new form of day trading in the investment world.
Many institutions that deal in cryptocurrencies do not require information about a person, which provides an element of anonymity. This has led to its use in more fraudulent or illegal activity, such as tax evasion or money laundering.
Many of the early days of cryptocurrency transactions were handled online through specific websites, including on the dark web. Now, many large businesses, including PayPal, Shopify, Subway, Expedia, Overstock, and Microsoft accept cryptocurrency. With Shopify and PayPal accepting it, those who hold this currency have the chance to use it to pay for goods or services with many smaller businesses who utilize PayPal or Shopify as their point of sale system. Most of these businesses only accept bitcoin, but some accept more.
Cryptocurrency as Income
According to the IRS, a virtual currency used as a substitute for or has a value equivalent to traditional currency is considered convertible virtual currency. For example, bitcoin can be traded between users, and it can also be purchased by or exchanged into other currencies. The IRS has declared that the use of this type of convertible virtual currency, whether in the exchange of or sale of them or to use it to pay for any services or goods, will be taxed the same as traditional currency. As such, it also has tax consequences in the United States.
Penalties for Not Declaring Cryptocurrency
If you have cryptocurrency considered convertible virtual currency and do not declare it on your tax return the same as you would other property or currency, then you may find yourself with issues. If the IRS audits you or otherwise finds that you have not properly reported this income, then you will be given a tax bill. You will also have to pay interest and penalty fees on the amount of tax you owe on this outstanding tax bill, which can quickly add up.
If the IRS reviews your account and determines that you have willingly hidden your cryptocurrency for fraudulent purposes or tax evasion, you could find yourself with criminal charges for tax evasion. This can lead to a fine of up to $250,000 and a prison term up to five years. If you are convicted of filing a false tax return rather than tax evasion, then you could still face a fine of up to $250,000 and a prison sentence, which caps out at three years.
What to Do
The IRS treats cryptocurrencies as property or any other type of currency, and as such, it must be handled the same as other property in your taxes. Therefore, you have to:
- Report transactions, including when using cryptocurrency to purchase other property
- Treat salaries paid in cryptocurrency the same way, often through issuing 1099-MISC forms or W2 forms
- Pay self-employment tax and payroll taxes as you would with traditional currency
- Follow standard income tax withholding
- Treat it like any other capital asset in terms of reporting gains or losses through the sale or exchange of it on the markets
Basically, you need to treat cryptocurrency in the same way that you would any other currency, investment, or asset. Whether you are a business that pays its employees in cryptocurrency, an investor playing the markets, or someone paying bills using this type of currency, you must declare these transactions on your tax return in the same way you would if you were to pay with credit cards, cash, foreign currency, or other methods of payments. If you are not sure how to handle this in your bookkeeping or tax returns, then talk with your accountant or tax preparer.
If you do end up with a tax bill that you cannot pay, either due to your unclaimed bitcoins or another reason, then contact Fidelity Tax Relief. Our tax professionals will review your situation and determine whether you qualify for one of the IRS’ fresh start initiatives, such as an Installment Agreement, Offer in Compromise, or Penalty Relief. You can also use our free online qualifying tool that takes 30 seconds to complete.