Cryptocurrency has quickly risen in popularity over the past decade. Originally popular among dark web users, a variety of cryptocurrencies have made their way into mainstream consciousness. Many users prefer the level of privacy that comes with this form of currency.
Of course, there are taxation issues with using virtual currencies. Using virtual currencies increases your tax reporting obligations, and there can be serious consequences for failing to report transactions and pay the tax resulting from cryptocurrency use. Experienced Tax Attorney Charlotte A. Erdmann and her team at Orlando Tax Law are well-versed and nationally recognized in the taxation of virtual currencies. Orlando Tax Law is one of the best choices nationwide when dealing with a virtual currency tax controversy issue.
Taxable vs. Non-Taxable Events
The question that many people have is whether virtual currency transactions are taxable. Like most taxation-based legal questions, the answer to this is: it depends. It is usually not a taxable event to purchase virtual currency from a cryptocurrency exchange, but it is a taxable event when that virtual currency was purchased or exchanged with other virtual currency.
Cryptocurrency as Property
The IRS considers virtual currency as property and not as currency. This is in contrast to how many countries treat virtual currency. Under IRS Notice 2014-21, a taxpayer must recognize gain or loss on the exchange of virtual currency for cash or other property or services. Gains and losses are taxable every single time that virtual currency is sold or used to purchase goods and services, including other types of virtual currency.
Cryptocurrency as Capital Gains Income
You need to know the basis of the virtual currency, when it was acquired in order and the fair market value of the virtual currency when sold or otherwise transferred, to determine the amount of capital gain or loss. The tax rate is also determined by how long a person has held the virtual currency before it is transferred. Short term capital gain occurs as a result of the exchange or sale when it is held less than one year. Long-term capital gain is the gain that occurs as a result of the exchange or sale when it is held for longer than one year. Currently, long-term capital gains are taxed at a lower rate.
Cryptocurrency as Income for Services
One of the areas in which the IRS has aggressively worked to crack down on cryptocurrency is when these digital forms of payment are used to pay someone for services. The federal government will not allow an individual to skirt the rules of taxable income by paying employees with digital currency. For that reason, the IRS considers cryptocurrency as earned income when it is transferred to someone in exchange for services performed and thus it is also subject to self-employment tax.
Reporting Virtual Currency Transactions and other Reporting Issues
The IRS tracks and enforces taxpayer compliance regarding virtual currency transactions. Form 1040 now provides a question asking if the taxpayer engaged in the transfer of virtual currencies in the prior year. You are allowed to answer “no” if you only purchased this currency and had no other transactions. Civil and occasionally criminal penalties are possible if you fail to report these transactions. This is considered an understatement of your income and you could be penalized up to 75% of that understatement if the IRS determines it was a civil fraud penalty. Talk to one of our cryptocurrency lawyers in Orlando to make sure you are not at risk of these penalties.
These reporting requirements are not for individual taxpayers alone – there are also implications for business taxpayers. Failure to report the payment of virtual currency in exchange for services can lead to information reporting penalties under Tax Code § 6721 and 6722.
Estate and Gift Tax Issues
The Estate and Gift Tax also apply to virtual currencies. Not only can cryptocurrency transactions potentially be reportable in the estate and gift tax context, but tax and penalties may be due as well.
Foreign Reporting Issues
If cryptocurrency is held or transferred “off-chain” in another country, or through a different country’s currency exchange, there may be federal foreign reporting requirements. Failure to comply with these federal banking and tax laws could lead to significant tax and penalties, regardless of whether a taxpayer is aware of their compliance obligations or not.
Virtual Currency Audits/Examinations and Letters 6173, 6174, and 6174-A
The IRS has stepped up its enforcement efforts in order to get taxpayers to disclose any virtual currency transactions. Some examples of this include filing a John Doe summons, sending letters out to taxpayers, and even a joint investigation between the civil and criminal divisions of the IRS to track cryptocurrency transactions, known as Operation Hidden Treasure.
The IRS uses John Doe summons to warn individuals who they suspect engaged in virtual currency transactions but did not properly disclose them. The IRS is currently sending IRS Form Letters 6173, 6174, 6174A, and CP2000 letters to taxpayers who have failed to report their cryptocurrency transactions.
Reach Out to an Orlando Cryptocurrency Tax Attorney Today
If you are facing an audit or examination involving a virtual currency, or received a letter 6173, 6174, 6174-A, or CP2000, please contact us today. The attorneys and staff at Orlando Tax Law are cryptocurrency tax attorneys and are well-versed in this new and emerging area of tax law. Attorney Charlotte Erdmann is nationally recognized with these issues and has taught other attorneys about these issues in continuing legal educations classes. She is also published as an authority on the subject.
Orlando Tax Law is not only prepared to represent you in your controversy or examination matter, but we can also take your case to court, if necessary. Call right away for a confidential consultation.