If you own Bitcoin or other cryptocurrencies – or if you have owned any crypto asset in the past – you owe obligations to the Internal Revenue Service (IRS) under the U.S. Tax Code. Here is an introduction to what you need to know:
Virtual Currency is Not Treated as “Currency” for U.S. Income Tax Purposes
The IRS has taken the position that “[u]nder currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.” However, this does not mean that investing in cryptocurrency is without federal income tax implications. On the contrary, cryptocurrency transactions can potentially trigger ordinary or capital gains tax, and cryptocurrency investors owe annual reporting obligations to the IRS.
Income Tax on Cryptocurrency is Determined on a Transaction-Specific Basis
Calculating gain or loss on a transaction involving cryptocurrency requires knowledge of the fair market value of the cryptocurrency at the time of receipt and at the time of transfer. The IRS states: “A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. . . . The basis of virtual currency . . . is the fair market value of the virtual currency in U.S. dollars as of the date of receipt.”
Buying Goods or Services with Cryptocurrency is a Taxable Event
Any time cryptocurrency is exchanged or transferred, this is considered a taxable event under the U.S. Tax Code. This means that cryptocurrency holders must carefully record all transactions and report the gain or loss from each individual transaction to the IRS.
Mining Cryptocurrency is Also a Taxable Event
The IRS has also taken the position that mining cryptocurrency is a taxable event. As a result, if you successfully mine Bitcoin or other cryptocurrency, during a tax year, you owe an obligation to the IRS. “[W]hen a taxpayer successfully ‘mines’ virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.”
The IRS is Enforcing U.S. Taxpayers’ Obligations with Regard to Cryptocurrency
In 2019 and 2020, the IRS sent letters to thousands of cryptocurrency investors warning that they may owe federal income tax as a result of their virtual currency holdings and transactions. Combatting cryptocurrency tax fraud is currently one of the IRS’s top priorities, and multiple offices and divisions are devoting resources to uncovering nonreporting and nonpayment of cryptocurrency-related income taxes.
Failure to Report or Pay Cryptocurrency-Related Tax Can Lead to Substantial Penalties
Cryptocurrency investors who are targeted in IRS audits and investigations can face substantial penalties. In addition to liability for unpaid taxes, this includes substantial interest and penalties, as well as the potential for federal criminal prosecution. As a result, cryptocurrency investors who have concerns about whether they have satisfied their federal income tax obligations should consult with an attorney promptly.
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