by Jake Wengroff
A looming question about bitcoin and other cryptocurrency revolves around whether it is taxable.
Over the years, the IRS has devised rules governing the taxation of cryptocurrency based on how it is used. Because crypto is often exchanged for fiat currency (i.e., dollars, euros), it is often called a convertible virtual currency because it has an equivalent value in real currency.
It is in the sale or exchange of a convertible virtual currency — including its use to pay for goods or services — that has tax implications. In its recent IRS Revenue Ruling 2019–24 and its Frequently Asked Questions article, the IRS answered some common questions about the tax treatment of virtual currency transactions
Below are three scenarios describing the tax implications of crypto and virtual currency.
1. As Payment for Goods and Services: Taxed as Income
Employers who pay employees in cryptocurrency must report employee earnings to the IRS on W-2 forms.
- Employers must convert the bitcoin or cryptocurrency value into U.S. dollars as of the date each payment is made and keep records.
- Wages paid in cryptocurrency are subject to withholding to the same extent as dollar wages.
As for employees, employees must report their total W-2 wages in dollars, even if their wages were earned in cryptocurrency. Self-employed individuals with cryptocurrency gains or losses from sales transactions also must convert the virtual currency to dollars as of the day received, and report the figures on their tax returns.
2. Held as Capital Assets: Taxed as Property
Simply buying cryptocurrency with U.S. dollars and keeping it within the exchange where the transaction occurred, or transferring it to a personal wallet, does not mean that taxes will be owed on that cryptocurrency at the end of the year.
However, like stocks or bonds, any gain or loss from the sale or exchange of the asset is taxed as a capital gain or loss.
“Just because your Coinbase portfolio drastically grew in value last year doesn’t mean that you’ll be writing out a check to Uncle Sam come April,” notes Nicolas Vega in CNBC.com. “Similar to trading stocks, you only need to list gains you earn from bitcoin as income when you decide to sell.”
3. Miners: Must Report Receipt of Virtual Currency as Income
Those who “mine” bitcoin and other cryptocurrencies also must deal with the IRS. The miner’s own computing resources that they’ve paid for, including hardware, software and electricity, are not taxed.
However, according to the IRS, when a taxpayer successfully “mines” the coins and has earnings from that activity, whether in the form of the cryptocurrency itself or in any type of service fees incurred in its acquisition, they must include those earnings in their gross income after determining the fair market dollar value of the virtual currency as of the day the cryptocurrency was received. For self-employed miners, their gross earnings minus allowable tax deductions are also subject to the self-employment tax.
Adding Title to Crypto
Improved record-keeping, even as it relates to taxes, is another reason why title is needed for crypto assets. For example, if an investor transfers cryptocurrency from a custodial exchange, such as Coinbase, to a self-hosted or proprietary wallet, it could be helpful to have title on that wallet to further document that this was not a taxable transaction but rather just a transfer.
As crypto assets move between various wallets and exchanges, proving title can help from an administrative or accounting perspective, especially as transactions grow in size and complexity.
Apart from tax considerations, security continues to be an ongoing issue for bitcoin and other cryptocurrency. This is because crypto is a bearer asset, meaning that whoever holds the private key is considered the owner. As such, demonstrating proof of ownership, should a private key be lost or stolen, can be difficult.
The industry is in need of infrastructure to verify the rightful ownership of cryptographic assets. TransitNet is currently developing the industry’s first offchain title registry of record for digital wallets. This will create an additional layer of protection and record-keeping for cryptocurrency assets.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, Jake covers such topics as security, mobility, e-commerce, and IoT.
TurboTax – Tax Tips for Bitcoin and Virtual Currency
CNBC.com – Do you owe taxes on your bitcoin?