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Article Highlights:
Character of the Gain or Loss – The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the taxpayer’s hands. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency held as a capital asset. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that he or she does not hold as a capital asset. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that would not be a capital asset.
Foreign Currency Transactions – Under currently applicable law, virtual currency is not treated as currency that could generate foreign currency gain or loss, for U.S. federal tax purposes.
Foreign Bank and Financial Account (FBAR) Reporting – The IRS stated a few years ago that virtual currency transactions need not be reported for purposes of foreign bank and financial account (FBAR) reporting. But the IRS cautioned that its position could change in the future. However, the IRS has not issued any announcements regarding a change in its position on FBAR filings for years through 2018.
Payment for Goods and Services – A taxpayer subject to U.S. taxation who receives virtual currency as payment for goods or services must, in computing his or her gross business 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.
Acquiring Virtual Currency – One can go to online exchanges and purchase virtual currency. But care should be taken to make sure the exchange is reputable. There are even virtual currency ATMs (kiosks) where cash can be exchanged for Bitcoin or other virtual currency. Once you have the virtual currency in your online wallet, you are free to spend it with anyone who accepts that form of currency.
Virtual Currency Mining – “Mining” is a term used to describe how cryptographic information distributed within a virtual currency network is secured, authorized, and approved. In essence, it is the processing of payments that have taken place once they occur. It takes the place of banks, merchants’ accounts, and clearing houses like Visa, which essentially eliminates all of the third parties’ cuts of income from the transaction. It involves complex mathematical logarithms that need to be solved, and the mining process completes this task autonomously. For individuals who mine virtual currency, it is a trade or business, and they are subject to self-employment tax.
Apparently, virtual currency miners are also subject to Form 1099-K filing requirements if their transactions rise to the reporting threshold. In general, a third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a third-party settlement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third-Party Network Transactions. 1099-K filing is required if, for the calendar year, both (1) the number of transactions settled for the merchant exceeded 200 and (2) the gross amount of payments made to the merchant exceeded $20,000.
Employee Payments – If an employee is paid in virtual currency, then the fair market value of the virtual currency paid as wages, measured in U.S. dollars, is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax (Social Security and Medicare A), and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2, Wage and Tax Statement. The U.S. government doesn’t accept virtual currency for tax payments.
Independent Contractor Payments – The fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income to the independent contractor and is subject to the self-employment tax. These payments are subject to the normal 1099-MISC reporting requirement when the payments for the year measured in U.S. dollars total $600 or more.
Virtual Currency and 1031 Exchanges - Beginning with 2018 returns, Sec. 1031 tax-deferred exchanges will only apply to real property; thus, investors in virtual currency who trade one type of virtual currency for another will be required to report their capital gains/losses and won’t be able to use the 1031 tax-deferral rules.
If you received one of the cryptocurrency education letters from the IRS and need assistance correcting previously filed returns, or if you are investing, trading, or dealing in virtual currency and have any questions about how those activities will affect your tax situation, please give this office a call.
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