Whether you are a hobbyist, day trader, or a high volume cryptocurrency investor, you will have to pay Federal income taxes on those transactions. Virtual or cryptocurrency is being treated as property by the IRS similar to stocks or real property.
Virtual currency is defined as “the various types of convertible currency that is used as a medium of exchange, such as digital currency and cryptocurrency. Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes.”1
In 2019 reporting crypto earnings was buried on Schedule 1. Schedule 1 is typically used to report income not listed on the Form 1040 itself and usually includes capital gains, alimony, or gambling winnings. 2020 was the first year that the question regarding crypto currency was inserted just below the taxpayer’s personal information and the Presidential Election Campaign. It states: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency? Yes or No”.2
Congress is currently trying to figure out how to regulate virtual currency by listening to expert witnesses. Under the proposed Biden Administration budget, the government is proposing giving the IRS an extra $80 billion and new powers to crack-down on tax dodgers, including those placing their cash in crypto. The country is losing over a trillion dollars a year in unpaid taxes and IRS Commissioner Charles Rettig credits this growing tax gap, at least in part, to this rise of the crypto market.3
Many people are even receiving a letter demanding tax payment from unpaid taxes on crypto currency income earned during the years 2013-2017. The letter states, “For one or more of tax years 2013 through 2017, we haven’t received either a federal income tax return or an applicable form or schedule reporting your virtual currency transactions.” The letter goes on to give the recipient 30 days to respond.3
Why is the IRS cracking down on crypto?
Let’s look at the history and valuation of the most popular cryptocurrency, Bitcoin. Since Bitcoin’s creation in January 2009, thousands of new cryptocurrencies have been launched, but Bitcoin (abbreviation BTC) remains the largest by market volume. The valuation history of BTC over the years is:
- Early 2010 – 1 BTC valued at a fraction of a U.S. penny
- First Quarter 2011 – 1 BTC exceeded a value of $1.00 U.S.
- Late 2017 – 1 BTC topped out around $20,000 U.S.
- Fourth Quarter 2021 – 1 BTC is valued at $49,000+ U.S.
So, it is not a surprise that the IRS wants what’s due to them for all of the capital gains cryptocurrency investors have incurred over the years.
Not many companies, other than Robinhood, are issuing 1099-Misc forms to tell you the capital gains of your cryptocurrency. But, just because you didn’t receive a 1099-Misc, it does not mean you don’t owe taxes. It would be like a contract employee not reporting wages earned because he didn’t receive a 1099 from his employer.
Keeping track of your cryptocurrency transactions can be a nightmare and if you are doing any significant volume in trading or selling crypto, we recommend hiring a cryptocurrency bookkeeper. There are several online cryptocurrency bookkeepers and, for an additional fee, they will do your taxes. One that we like is https://www.zenledger.io/ .
So if your kid is in his room trading crypto like it’s a game, be aware that any cryptocurrency wallet valued at more than $600 is subject to tax. A cryptocurrency bookkeeping software might be a good way to keep track of transactions.
Now, you may be wondering how cryptocurrency or bitcoin is taxed. It truly depends on the volume of transactions and the valuation of the capital gains on those transactions in the given tax year. But know anytime you sell, trade, or use cryptocurrency for other cryptocurrency, goods, or services, you are creating a capital gains event. If you want to know exactly if your transaction is taxable, the IRS has put together comprehensive FAQs on Virtual Currency Transactions.1
In the end, be aware, be responsible, and be educated about cryptocurrency and taxes before you get too far down the road with your investments.
2 Form 1040, U.S. Individual Income Tax Return 2020
3 https://www.cnbc.com/2021/07/14/irs-new-rules-on-bitcoin-ethereum-dogecoin-trading McKenzie & Sigalols, July 14, 2021
Would you like to contact our team with questions you may have regarding cryptocurrency taxes? Contact us!