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Days after the Internal Revenue Service (IRS) released two new pieces of guidance for taxpayers who engage in transactions involving virtual currency, the IRS announced another compliance measure: a checkbox on form 1040. The checkbox, which appears on the early release draft of the form 1040, asks taxpayers about financial interests in virtual currency.

The checkbox appears on the second early release draft of the 2019 Form 1040, Schedule 1, Additional Income and Adjustments to Income (downloads as a PDF). The checkbox is at the top of Schedule 1, which is used for reporting income or adjustments to income that can’t be entered directly on the front page of form 1040:

1040 crypto question

The question is:

At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?  

If you’re wondering why that sounds familiar, the wording closely parallels the verbiage on Schedule B, Part III, concerning offshore accounts. That question appears at the bottom of the Schedule. It asks:

At any time during 2018, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country? 

The similarities aren’t surprising. You may recall that I’ve suggested before that the strategy the IRS is using to pursue cryptocurrency is reminiscent of how the agency chased down offshore accounts.

However, I’m not overly keen on the location of the cryptocurrency question. As noted, taxpayers who file Schedule 1 to report income or adjustments to income that can’t be entered directly on Form 1040 should check the appropriate box to answer the virtual currency question. But taxpayers who don’t have to file Schedule 1 for any other purpose may not be aware that they need to file Schedule 1 to answer to this question if it applies to them. Yes, tax software interviews will likely catch it – but what if they don’t? Or what if taxpayers are completing the form by hand? Or if tax preparers don’t think to ask? 

I think it’s something that IRS will need to address. The IRS will accept Schedule 1 comments via email at WI.1040.Comments@IRS.gov for a 30-day comment period beginning October 11, 2019. The IRS cannot respond individually to each comment received, but all feedback will be considered.

Why does the location of the checkbox matter? Compliance. The checkbox is ostensibly on the form to remind taxpayers to report their cryptocurrency transactions. But those tax professionals like me who have seen the response to the checkbox on Schedule B know that this is also an easy way to hold those who don’t check the box – even by accident – accountable. The IRS can and has taken the position that willfully failing to check the box related to offshores interests can form the basis for criminal prosecution. Failing to check the box by accident can still result in headaches and penalties. I fully expect a similar result on the cryptocurrency side.

If you’re looking for more information on cryptocurrency, you can read more about the recent guidance here. You can find out more about the taxation of cryptocurrencies like Bitcoin here. And you can get up to date about how the IRS is targeting non-compliance through a variety of efforts, ranging from taxpayer education to audits to criminal investigations here.

The United States may be taking a hard line on cryptocurrency, but not all countries are seeking to collect from the virtual currency boom. The Portuguese Tax & Customs Authority (PTA) has announced that buying or selling cryptocurrency in Portugal is tax-free. 

The announcement came at the same time that the Internal Revenue Service (IRS) has announced a crackdown on cryptocurrency (more on that here). However, Portugal has taken the opposite tack: it made clear that buying or selling cryptocurrencies would not be subject to capital gain taxes or value-added tax (VAT). The PTA previously clarified in 2016 (downloads in Portuguese as a PDF) that buying or selling cryptocurrency in Portugal would not be considered a taxable event which means that it’s not subject to tax. There are exceptions: the receipt of cryptocurrency in exchange for goods or services doesn’t change the tax treatment of the original transaction, and taxpayers who deal in cryptocurrency as a professional or business activity are still subject to some taxes.

A VAT is similar to a sales tax, but not quite the same thing. A sales tax is a tax typically tacked onto the end of a sale of goods or services, much like state and local sales taxes are imposed. A value-added tax is a consumption tax but, unlike a sales tax, it’s collected at every stage along the production chain. (You can read more about VAT here.)

The news was first reported in a local paper, Jornal de Negócios. The paper reviewed an official document (in Portuguese, downloads as a PDF) from the PTA in response to a company that planned to mine cryptocurrency. The tax agency cited Article 135 (1)(e) of Council Directive 2006/112/EC (downloads as a PDF) which exempts “transactions, including negotiation, concerning currency, banknotes, and coins used as legal tender, with the exception of collectors’ items, that is to say, gold, silver or L 347/28 EN Official Journal of the European Union 11.12.2006 other metal coins or banknotes which are not normally used as legal tender or coins of numismatic interest” from VAT.

That means that Portugal will treat cryptocurrency as a form of currency, making it exempt from VAT and capital gains. That’s consistent with its policy on other currencies: Portugal does not tax the gain on the value or sale of any currency.

Not all European Union (EU) countries completely agree with Portugal. For example, the PTA cited a Swedish court case, Skatteverker (Administração Fiscal Sueca) v. David Hedqvist, in which the court ruled that trading cryptocurrency was not subject to VAT. However, the Swedish Tax Administration appealed that decision and it eventually advanced to the European Court of Justice (ECJ) where it was upheld. Other EU countries have taken various positions on the taxation of cryptocurrency depending on how it was obtained and how it was used.

The U.S. has, since 2014, consistently treated cryptocurrency as a capital asset if it can be converted into cash. This means that capital gains rules apply to any gains or losses. (You can read more on the taxation of cryptocurrencies like Bitcoin according to the IRS here.)

With the announcement, Portugal has made it clear that it is – at least for now – a tax-friendly home for those who buy and sell cryptocurrency. But don’t pack your bags just yet: Remember that U.S. citizens are taxed on their worldwide income, meaning that a trip across the pond won’t be enough to slash your tax bill.

Taxpayers who deal – or even dabble – in virtual currency may be on the receiving end of a letter from the Internal Revenue Service (IRS) this month. The IRS has announced that they have begun sending letters to taxpayers who might have failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly.

The IRS started sending letters to taxpayers last week. The names of these taxpayers were obtained through various ongoing IRS compliance efforts.

(For more on some of those efforts – like the Coinbase court saga – click here.)

There are three variations on the letter: letter 6173, letter 6174, or letter 6174-A. The letters are allegedly targeted to taxpayers depending on the information available to the IRS. According to the IRS, “[a]ll three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors.” However, all three versions are not the same; one version alleges noncompliance while another merely indicates that the IRS has been made aware of cryptocurrency activity attached to the taxpayer.

Depending on the version of the letter you receive, your next steps may vary. But if you’re one of the more than 10,000 taxpayers expected to receive a letter by the end of August, don’t ignore the IRS.

“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

This campaign is not one of the six compliance campaigns for taxpayers announced earlier this month. It is, however, one of the IRS campaigns announced last year to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers.

A compliance campaign is a targeted directive on a particular issue; they happen when the IRS determines that there are taxpayer issues that require a response from the agency. When the IRS announces a campaign (or campaigns), it’s a signal that they will be dedicating time, resources, training, and tools towards a tax compliance goal. To date, the IRS has announced a total of 59 campaigns.

(You can read more about the most recently announced compliance campaigns here.)

In 2014, the Internal Revenue Service (IRS) issued guidance to taxpayers (downloads as a PDF) making it clear that virtual currency will be treated as a capital asset, provided they are convertible into cash. In simple terms, this means that capital gains rules apply to any gains or losses. (You can read more on the taxation of cryptocurrencies like Bitcoin here.)

However, two years later, in 2016, only 802 individual tax returns out of the 132 million filed electronically with the IRS reported income related to cryptocurrencies. The government is clearly seeking to increase compliance.

According to the IRS, the agency will continue to follow-up on cryptocurrency compliance through a variety of efforts, ranging from taxpayer education to audits to criminal investigations. The IRS has also warned that taxpayers who do not properly report can be liable for tax, penalties, and interest; in some cases, taxpayers could be subject to criminal prosecution.

If all of this sounds familiar, you’re not mistaken. There are clear parallels between the IRS’ focus on cryptocurrency and the prior targeting of offshore accounts. Investigations into offshore accounts began with subpoenas to financial institutions and eventually became a full-fledged IRS compliance initiative. Unlike offshore account disclosure, however, the IRS has signaled that it will not offer an amnesty program (it’s worth noting that many tax professionals question whether that will stick).

The issuance of these cryptocurrency “educational” letters is intended to be a warning shot to taxpayers. The IRS says to expect additional legal guidance in this area in the near future.

By now, most taxpayers understand that there are tax consequences associated with cryptocurrency, but ironically, until recently you couldn’t pay those taxes using cryptocurrency. That’s about to change: With the launch of OhioCrypto.com, Ohio will become the first state in the nation to accept tax payments using cryptocurrency.

“We are proud to make Ohio the first state in the nation to accept tax payments via cryptocurrency,” said Ohio Treasurer Josh Mandel. “We’re doing this to provide Ohioans more options and ease in paying their taxes and also to project Ohio’s leadership in embracing blockchain technology.”

Under the new payment system, not all taxpayers can make payment in cryptocurrency: It’s limited to businesses operating in Ohio. Offering the service to individual taxpayers is on the agenda, but Mandel hasn’t indicated any specific timeframe for the expansion.

Here’s how it works: If you operate a business in the State of Ohio and you have a tax bill, you can register online at OhioCrypto.com to pay your taxes. You can make payments on any of 23 eligible business-related taxes (you can find a list here), and there is no transaction limit.

The Treasurer’s office isn’t holding, mining or investing in cryptocurrency for payments or processing. All cryptocurrency payments are processed by a third-party cryptocurrency payment processor, BitPay. Those payments are immediately converted to dollars before being deposited into a state account.

“The State of Ohio is the first major government entity offering its citizens the option to pay with cryptocurrency,” said Stephen Pair, cofounder and CEO of BitPay. “With BitPay, Ohio can leverage blockchain technology and benefit from reduced risk and identity fraud as well as enabling quick and easy payments from any device anywhere in the world and get paid in dollars. This vision is at the forefront of moving blockchain payments into mainstream adoption.”

You’ll need to use Payment Protocol-compatible wallets to pay. Those include BitPay Wallet; Copay Wallet; BTC.com Wallet; Mycelium Wallet; Edge Wallet (formerly Airbitz); Electrum Wallet; Bitcoin Core Wallet; Bitcoin.com Wallet; BRD Wallet (breadwallet); and Bitcoin Cash (BCH) Wallets. If you don’t have one of these wallets, OhioCrypto.com advises you to create one and send some coin to it.

Currently, the Treasurer’s office only accepts Bitcoin for payment, but the plan is to add other cryptocurrencies in the future.

There is a cost associated with paying in cryptocurrency (it’s worth noting taxpayers who pay via credit cards or debit cards are also subject to fees from payment providers but are not assessed fees through the Treasurer’s office). Taxpayers paying using cryptocurrency are charged a transaction fee, network fee, and a miner fee. The miner fee will be displayed in the taxpayer’s wallet and not on OhioCrypto.com. The transaction fee will be 0% during an initial three-month introductory period, and after that time, it will be 1%. Fees are user fees and are not supplemented by state funds.

According to the Treasurer’s Office, “The State of Ohio will not pay Bitpay or any other company fees for processing or other services relating to the acceptance of crypto.”

It will be interesting to see if other state governments follow suit. A bill to accept bitcoin as payment for taxes was ultimately voted down, 264 to 74, by the New Hampshire legislature in 2016. A similar measure in Utah also failed to pass, while a bill to accept crypto for payments in Georgia stalled earlier this year. However, states are still trying: Arizona’s state legislature actually passed a crypto payment measure, but it was vetoed on May 16, 2018.

The Internal Revenue Service (IRS) doesn’t currently accept cryptocurrency as payment either. By law, the IRS issues Regulations (interpretations of the tax code) and other guidance about the kinds of payment which can be used to pay taxes. The IRS has authorized payment by check, money order, credit card and debit card—but not by Bitcoin or other cryptocurrency. (You can find more ways to pay your IRS tax bill here.)

Finding yourself confused about the tax treatment of virtual currency? You’re not alone. The perplexing and often onerous tax rules have not been simplified (or clarified), even as the numbers of investors and available virtual currencies have exploded. The last time that the Internal Revenue Service (IRS) issued specific guidance on the tax treatment of virtual currency to taxpayers was on March 25, 2014, at a time when about $14,020,100 worth of Bitcoin was trading at around $585. As of this writing, volume share is approximately $4,631,500,000 trading at around $7,500 a pop. And that’s just bitcoin (BTC). It doesn’t include other virtual currencies like Ripple or Ethereum.

(You can download the official 2014 IRS guidance as a PDF here.)

The guidance made it clear that, for tax purposes, virtual currency is treated as a capital asset, provided that it is convertible into cash. In simple terms, this means that capital gains rules apply to any gains or losses. But taxes are never quite that simple, and more guidance is needed, not only to clarify questions from the initial notice but also to address unexpected events like forks and splits.

(You can read more about the tax treatment of virtual currencies, including cryptocurrency, here.)

The clamor for more guidance comes at a crucial moment. The IRS is demanding more compliance after alleging that some users have been using virtual currency to avoid tax-reporting requirements. To prove their point, the IRS demanded that Coinbase, a company which facilitates transactions of digital currencies like Bitcoin and Ethereum, turn over customer data. After a lengthy court battle, Coinbase eventually notified a subset of its customers that it would comply with a court order regarding the release of specific data. As part of its press, the IRS had argued that “only 800 to 900 taxpayers reported gains related to bitcoin in each of the relevant years” while “more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin in a given year.” That, the court wrote in its order, “suggests that many Coinbase users may not be reporting their bitcoin gains.”

(You can read more about the legal history here. You can read the court’s order here.)

While the question of whether willful avoidance or confusion has resulted in below-expected reporting numbers remains, many tax professionals believe that further guidance would benefit taxpayers. One group, the American Institute of Certified Public Accountants (AICPA), recently sent a letter to the IRS requesting that the agency issue additional and “immediate” guidance.

Annette Nellen, CPA, CGMA, Esq., chair of the AICPA Tax Executive Committee, penned the letter to the IRS, emphasizing that “[t]he rapid emergence of virtual currency has generated several new questions on how the tax rules apply to various transactions involving virtual currency and activities and assets related to it.” Additionally, Nellen said, “the development in the number of types of virtual currencies and the value of these currencies make these questions both timely and relevant to a growing number of taxpayers and tax practitioners.”

The letter went on to recommend that the IRS specifically address issues in 12 areas:

  1. Expenses of Obtaining Virtual Currency
  2. Acceptable Valuation and Documentation
  3. Computation of Gains and Losses
  4. Need for a De Minimis Election
  5. Valuation for Charitable Contribution Purposes
  6. Virtual Currency Events
  7. Virtual Currency Held and Used by a Dealer
  8. Traders and Dealers of Virtual Currency
  9. Treatment under §1031 (like-kind exchanges)
  10. Treatment under §453 (installment sales)
  11. Holding Virtual Currency in a Retirement Account
  12. Foreign Reporting Requirements for Virtual Currency (FBAR and FATCA)

The AICPA recommended that the IRS consider frequently asked questions (FAQs), including how to calculate expenses (including depreciation) and whether taxpayers may use averages of different exchanges when calculating values.

The FAQs also note the need for a de minimis election. The Latin phrase de minimis translates roughly to “of little importance.” You may recall that in the tax world, the phrase is used to indicate when IRS considers items “so small as to make accounting for it unreasonable or impractical.” Since tracking the basis and value of virtual currency for small purchases—like shopping—can be time consuming and burdensome for what is, in most cases, a small amount of taxable gain or loss, the AICPA recommends that there be an exclusion similar to the one which exists for foreign currency for personal transactions (up to $200 per transaction).

The FAQs also address issues which had not been contemplated in the original guidance: virtual currency events like chain splits, airdrops and giveaways. Notably, the AICPA recommends that the IRS clarify tax treatment following the Bitcoin split of 2017. The AICPA suggests that the IRS should take the position that “[t]axpayers have the option to report events as they deem appropriate.” However, as part of reporting, if the taxpayer chooses to make an “Election to Include a Virtual Currency Event as Ordinary Income in Year of Transfer,” the IRS should not challenge that method of treatment for 2017. Specifically, the AICPA writes, “a taxpayer makes the election that states they received Bitcoin Cash in the August 2017 split event and the currency has zero basis.”

Another popular topic that was not considered under the prior guidance is how to report virtual currency held in retirement funds—and what’s permissible. The AICPA writes that IRS should clarify that since virtual currency is treated as property (remember that it’s a capital asset), it would be permissible in an IRA. However, the AICPA notes that “[t]axpayers need guidance on whether other types of retirement accounts, if any, can hold virtual currencies. The IRS should also provide guidance on what special documentation rules or requirements apply given the decentralized nature of virtual currencies and the various ways these currencies are held and transferred.”

And what about those FBARs? In 2014, I reported that, in response to my query, the IRS issued a statement:

The Financial Crimes Enforcement Network, which issues regulatory guidance pertaining to Reports of Foreign Bank and Financial Accounts (FBARs), is not requiring that digital (or virtual) currency accounts be reported on an FBAR at this time but may consider requiring such accounts to be reported in the future. No additional guidance is available at this time.

Since that time, I’ve been asked many times for an update. The IRS has not issued an update, nor formal guidance. I suggested, and the AICPA seems to agree, that individually held currencies, such as those in wallets, should not be subject to FBAR reporting. However, neither IRS nor Treasury has provided guidance on whether virtual currency accounts may become reportable. The AICPA also asked for formal direction on whether additional reporting obligations might exist under the Foreign Account Tax Compliance Act (FATCA).

The IRS has not responded publicly to the AICPA. You can read the 21-page letter, which downloads as a PDF, here.

So what should you do in the meantime?

  • If anything, I think the AICPA letter emphasizes the need for taxpayers to remain a part of the conversation. Stay informed and be heard. How virtual currency is being traded and used, as a practical matter, should drive how the IRS chooses to treat it for tax purposes.
  • Also, keep excellent records. One of the problematic issues I’ve seen from taxpayers is a lack of tracking when it comes to trading one cryptocurrency for another. Cashing cryptocurrency out of an exchange or similar platform may be treated as a sale—even if you’re forced to withdraw it. You’ll want to be able to track your basis, costs, and gains as you go, not as the IRS may see it. (Again, you’ll find more on basis and tax treatment of trades and withdrawals here.)
  • And, of course, make friends with a good tax professional. There’s a lot to see here, and you’re going to want someone who is knowledgeable to stay on top of things.
  • Above all, be patient. As Nellen writes, “The issuance of clear guidance in this area will provide confidence and clarity to preparers and taxpayers on application of the tax law to virtual currency transactions.”
It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss, you won’t want to miss a single letter.

K is for Kin (Crypto)

Kin (KIN) is a digital currency created to incentivize users to interact with Kik, an instant messaging app. Kin announced its debut on May 25, 2017, describing the new cryptocurrency as “designed specifically to bring people together in a new shared economy.” Kin was implemented on the public Ethereum blockchain as an ERC20 token.

As a cryptocurrency, Kin is similar to Bitcoin (BTC). Like Bitcoin, Kin has monetary value, though the intent is focused on trading for goods and services on the Kik platform rather than investing. In fact, Kik envisions that Kin will hold “real value both inside and outside of the chat application.”

Kik is one of more than 1,600 cryptocurrencies available today. Some currencies like Bitcoin, Ethereum (ETH), and Ripple (XRP) have names that people recognize. But others, like VeChain (VEN), Nano (NANO), and Zcash (ZEC) are just picking up steam as interest in crypto and digital currencies grows. Unfortunately, the relatively meteoric rise of many of these currencies means that guidance – both in terms of investing and taxes – may be limited. If you’re tempted to dip your toes into the crypto world, here’s what you need to know for federal income tax purposes.

The first thing to understand is that just because you don’t physically hold cryptocurrency in your hands (or in your non-virtual wallet) doesn’t mean that it’s not taxable. In 2014, the Internal Revenue Service (IRS) issued guidance to taxpayers (downloads as a PDF) making it clear that virtual currency is taxable and is treated as a capital asset, provided that it can be converted into cash. This doesn’t mean that the currency has to be converted into cash, just that it can be.

Capital asset treatment means that for taxpayers buying and selling cryptocurrency as an investment, calculating gains and losses are figured the same as buying and selling stock. For those taxpayers treating cryptocurrency like cash – spending it directly for goods or services, or using it to buy other cryptocurrencies – the individual transactions may result in a gain or a loss.

At tax time, you’ll report realized gains and losses on a Schedule D, Capital Gains and Losses (downloads as a PDF). You’ll transfer those numbers to the front page of your federal form 1040. There’s no need to file a Schedule D if there are no realized gains or losses (even if the value changes, if there’s no sale or other disposition, there’s nothing to report).

Schedule D assumes that reporting isn’t complicated. If all of your forms 1099-B (statements from a brokerage showing sales price and basis) are complete with no gaps, then a Schedule D will suffice.

But today’s tax world hasn’t necessarily caught up to today’s digital world. Most of the time, proceeds and basis from sales or exchanges of crypto aren’t reported to you on a form 1099-B. If that’s the case, you’ll need to file form 8949, Sales and Other Dispositions of Capital Assets in addition to a Schedule D.

For most taxpayers, the focus is on Part I of the form, used for Short-Term transactions. That’s because crypto is often used and traded throughout the year and not merely held for investment. And a transaction isn’t limited to a sale: Anyone using cryptocurrency to pay for goods or services must treat each purchase as a sale. Ditto for trading one cryptocurrency for another.

The line between long-term and short-term is a bright one. If you hold an asset for more than one year before a taxable event, it’s considered a long-term gain or loss. In contrast, if you hold an asset for one year or less before a taxable event, it’s considered a short-term gain or loss.

Form 8949

If you’re lucky enough have a form 1099-B reporting your transactions,  you’ll tick box A or B on the form 8949. But in most cases, you’re going to check box C because there is no form 1099-B for crypto transactions since the IRS doesn’t require third-party reporting for virtual currency. Some companies, like Coinbase, will offer a summary of transactions which can be used to help you file your taxes but if you withdraw cryptocurrency from an exchange, the exchange can no longer track when happens. In that event, cashing cryptocurrency out of an exchange or similar platform may be treated as a sale.

You’ll report the property, date of acquisition, date of sale, sale price and basis (cost that you paid plus any adjustments) on the form, line by line. You’ll figure your capital gains (and losses) by calculating how much your basis has gone up or down from the time you acquired the cryptocurrency until there’s a taxable event (disposition/sale/exchange). You’ll then net your gains and losses, and pay any tax due.

For a deeper dive on crypto and taxes (with some examples), check out this article.

If you’re tempted to skip reporting at tax time, don’t. The IRS is increasingly interested in taxpayers who use crypto and have taken note of the disparity between market transactions and reported transactions. As a result, the IRS is aggressively pursuing crypto as a compliance target. Their first shot across the bow was largely a success: They recently won the right to access some of Coinbase’s customer data.

For your taxes from A to Z, here’s the rest of the series:

Taxpayer asks:

Dear Taxgirl,

Just for fun can people pay their taxes with bitcoin?

Taxgirl says:

Unfortunately, no. Nor can taxpayers pay their taxes with loose diamonds even though, they, too, have value. And typically, most taxpayers can’t pay in Botswana pulas or Russian rubles either. So what can you use? Let’s take a look.

By law, at 31 U.S.C. 5103, you can pay your taxes using U.S. money:

United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues.

It’s worth noting that law is found at Title 31 (Money and Finance), and not Title 26 (Internal Revenue Code). That’s because not all laws which affect your taxes are specific to the Tax Code. Since Internal Revenue Service (IRS) is an arm of the federal government, it is also subject to other regulations like this one from the Bureau of Fiscal Service (BFS) which confirmed that IRS would no longer accept checks for $100 million or more.

But even when an issue is directly related to IRS, you won’t necessarily find a corresponding provision in the Tax Code. Consider the issue of paying in foreign currency, for example. On the IRS website, it notes that “Payments of U.S. tax must be remitted to the U.S. Internal Revenue Service (IRS) in U.S. dollars” – even for foreign electronic payments.  But if you check the Tax Code, you won’t find specific language requiring that those taxes be paid in U.S. dollars, just like there’s nothing in the Code that says no to payments of bitcoin or loose diamonds. Here’s what the Code actually says (section 6311):

It shall be lawful for the Secretary to receive for internal revenue taxes (or in payment for internal revenue stamps) any commercially acceptable means that the Secretary deems appropriate to the extent and under the conditions provided in regulations prescribed by the Secretary.

That’s a fancy way of saying that the IRS will issue Regulations (interpretations of the tax code) and other guidance about the kinds of payment which can be used to pay your taxes so long it doesn’t run afoul of other rules. And the IRS has done so, authorizing, for example, payment by check, money order, credit card and debit card.

What about other forms of payment? Paying in foreign currency has been addressed – it’s allowed under limited circumstances. But paying in bitcoin (or loose diamonds) has not specifically been authorized, and even if you wanted to argue that the specific omission of bitcoin or loose diamonds shouldn’t preclude using those as payment for taxes, you’d likely lose under a statutory interpretation of what’s considered “commercially acceptable.”

That said, if you really had your heart set on paying your taxes in bitcoin, you could investigate using a third party. Bitcoin-based shopping cart Snapcard tried its hand at it in 2014 with a service that allowed customers to pay the IRS. The service Snapcard worked like a payment processor (think MasterCard) and processing fees applied. However, Snapcard has since repivoted and launched a product in 2015 called “Masspay” that became Wyre. According to a spokesperson from the company, “Paying the IRS with bitcoin is something that we’re not offering at the moment.”

Of course, just because IRS doesn’t accept cryptocurrency like bitcoin as direct payment today doesn’t mean that will always be the case. A bill to accept bitcoin as payment for taxes was ultimately voted down, 264 to 74, by the New Hampshire legislature in 2016: The state was angling to be the first in the country to accept bitcoin as payment for taxes. A similar measure in Utah also failed to pass. However, states are still trying: Arizona introduced a crypto payment measure just this year. I suspect it’s just a matter of time before we see some changes.

(Author’s note: An email to IRS asking whether there were any plans in the near future to accept bitcoin as payment was not immediately returned.)

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Cryptocurrency is riding high these days. But even as more investors are taking a chance on new currencies like Bitcoin, Ethereum, and Ripple, many are still confused about how to treat it for federal income tax purposes. In 2014, the Internal Revenue Service (IRS) issued guidance to taxpayers (downloads as a PDF) making it clear that virtual currency will be treated as a capital asset, provided they are convertible into cash. In simple terms, this means that capital gains rules apply to any gains or losses. But taxes are rarely simple. Things can get complicated very quickly.

Here are the basics:

  • For those taxpayers buying and selling cryptocurrency as an investment, calculating gains and losses are figured the same as buying and selling stock. That’s true, as well, when it comes to basis, holding period and a triggering event.
  • For those treating cryptocurrency like cash – spending it directly for goods or services, or using it to buy other cryptocurrencies – the individual transactions may result in a gain or a loss.

I know, the basics aren’t quite so basic. Here’s a deeper dive into some of the more complicated bits:

First, how do you calculate capital gains?

For tax and accounting purposes, capital gains and losses are calculated by determining how much your cost basis has gone up or down from the time you acquired the asset (in this case, cryptocurrency) until there’s a taxable event.

Okay, you’ve already lost me. What’s basis?

Basis is, at its most simple, the cost that you pay for assets. The actual cost is sometimes referred to as “cost basis” because you can make adjustments to basis over time. For example, if you add to the asset, either as a new purchase or a reinvestment, your basis is your cost plus the cost of each subsequent purchase/reinvestment.

Got it. When I trade cryptocurrency on an exchange, I pay commissions and fees. How do I treat those costs?

When you calculate your basis, you’ll figure the purchase price plus any related costs, such as commissions.

You treat fees differently: If you pay investment-related fees, then you may be able to deduct the fees on your Schedule A, assuming you itemize. But that’s only for 2017. The new tax reform law eliminated the deduction for 2018 through 2025 but there is a work-around: If, instead of owning cryptocurrency personally, your business owns the investments, you can deduct investment-related fees on a Schedule C (or your entity’s tax form).

So what’s a taxable event?

A taxable event is typically a sale or disposition of an asset. When it comes to cryptocurrency, a taxable event occurs whenever it is traded for cash or other cryptocurrency or whenever cryptocurrency is used to purchase goods or services.

There’s also another potentially complicating factor. The IRS doesn’t require third-party reporting for virtual currency (yet) so there’s no form 1099-B or equivalent issued at the end of the tax year. Some companies like Coinbase will offer a summary of transactions which can be used to help you file your taxes but if you withdraw cryptocurrency from an exchange, the exchange can no longer track when happens. In that way, it’s the same as taking money out of your bank. For that reason, cashing cryptocurrency out of an exchange or similar platform may be treated as a sale – even if you’re forced to withdraw it. (Remember: There’s very little official guidance right now.)

And what’s a holding period?

The holding period is the period of time that you own or have access to the asset – typically, the time frame between acquisition and the taxable event.

  • If you hold an asset for more than one year before a taxable event, it’s considered a long-term gain or loss.
  • If you hold an asset for one year or less before a taxable event, it’s considered a short-term gain or loss.

Ok, great. Being taxed as capital gains is a good thing, right, because those tax rates are better than normal?

Sort of. Capital gains rates can be favorable to taxpayers. For 2017 (the return that you’ll file when tax season opens in January 2018), capital gains rates for long term gains (those held more than a year) range from 0% to 20%. Short-term capital gains are taxed as ordinary income, which means your marginal tax rate will apply to your short-term gains as well.

But I don’t pay tax unless I actually cash out, right?

Nope. This is one of the problems. You may have a taxable event even if you don’t formally cash out. Anyone using cryptocurrency to pay for goods or services must treat each purchase as a sale. Ditto for trading one cryptocurrency for another.* I know there’s confusion over this treatment, but think of it like this: If you trade in your Amazon shares for Microsoft shares, that’s a taxable transaction, even if you don’t take cash out of your brokerage account. Same analysis.

(*Note: I’m not going to address section 1031 issues here because it’s beyond the scope of this post and because it’s disallowed for cryptocurrency under the new tax reform law. If you’re reading this and you have no idea what section 1031 is, don’t panic: It likely doesn’t apply to you.)

What if I lose money?

If your realized losses exceed your realized gains, you have a capital loss for tax purposes. You can claim up to $3,000 (or $1,500 if you are married filing separately) of capital losses and the amount of your loss offsets your taxable income for the tax year. If your losses exceed those limits, you can carry the loss forward to later years subject to certain limitations and restrictions.

Realized gains and losses? What does that mean?

Cryptocurrency has been up and down over the past year. For tax purposes, you mostly care about the beginning and the end: what happens in the middle doesn’t really count. For example, every time that Bitcoin takes a dive, that doesn’t equal a real, or realized loss. Similarly, when it goes back up, that doesn’t equal a real, or realized gain. To realize a gain or a loss for tax purposes, you have to do something with the asset. Typically, that means that you sell it or otherwise dispose of it – generally, the taxable event mentioned earlier.

Here’s a quick example to help you sort out the math: Assume you invest in Bitcoin worth $1,000. Over the year, assume that the value of the Bitcoin climbs to $25,000 due to market conditions and not any additional investment on your part. You continue to hold onto it. Result? Unrealized gain, no capital gain. Now assume that the value of Bitcoin takes a hit and it falls to $500. Result? Unrealized loss, no capital loss. Finally, assume that Bitcoin climbs back to $750 and you get rid of it. Result? You have a realized capital loss of $250 ($750 selling price – $1,000 basis). You take the loss at the basis, not the high price (the $25,000 high value is meaningless for purposes of capital gain or loss) nor at the low price (the $500 low value is similarly meaningless for purposes of capital gain or loss). You want it to mean something. But it doesn’t. At least not for tax purposes.

So where do I report my gains or losses?

At tax time, you’ll report your realized gains and losses on a Schedule D, and then transfer the results to the reconciliation page on your federal form 1040. You don’t file a Schedule D if you don’t have any realized gains or losses: even if the value changes, if there’s no sale or disposition, there’s nothing to report.

Got it. So what if I invest in cryptocurrency outside of the United States. I know that I have to report brokerage accounts and other assets on an FBAR. Does that apply here?

Nope, you don’t have to report your cryptocurrency on your FBAR. In 2014, the IRS issued a statement, saying, “The Financial Crimes Enforcement Network, which issues regulatory guidance pertaining to Reports of Foreign Bank and Financial Accounts (FBARs), is not requiring that digital (or virtual) currency accounts be reported on an FBAR at this time but may consider requiring such accounts to be reported in the future.” The IRS has confirmed that position for this year.

Since I don’t have to report it on an FBAR, what happens if I just don’t report it all, anywhere?

The IRS has been cracking down on cryptocurrency reporting. They’ve made some headway into investigating potentially unreported transactions, including some initial success in legal efforts to force Coinbase to turn over customer records. It’s likely not an isolated push: In the Coinbase matter, IRS Senior Revenue Agent David Utzke noted that for the 2013 through 2015 tax years, the IRS processed, on average, just under 150 million individual returns annually. Of those, approximately 84% were filed electronically. IRS matched data collected from forms 8949, Sales and Other Dispositions of Capital Assets, which were filed electronically and found that just 807 individuals reported a transaction on Form 8949 using a property description likely related to bitcoin in 2013; in 2014, that number was just 893; and in 2015, the number fell to 802. The IRS argues that those numbers indicate that taxpayers aren’t reporting or paying tax on cryptocurrency transactions.

The takeaway? It’s no secret that IRS is making reporting cryptocurrency a compliance priority. Stay ahead of the game by making sure your records and tax reporting are above-board.

The federal government fired back last week as answered opposition to its ongoing court case between the Internal Revenue Service (IRS) and Coinbase, a company which facilitates transactions of digital currencies like Bitcoin and Ethereum. On Friday, the government filed answers to amicus curiae briefs filed by Competitive Enterprise Institute (CEI), Digital Currency & Ledger Defense Coalition (DCLDC), and Coin Center. The government also responded to opposition filed by Coinbase and John Doe 4.

Amicus curiae is a Latin phrase meaning “friend of the court.” For legal purposes, an amicus curiae is a party who is not formally involved in the case – meaning neither a plaintiff nor a defendant – but someone (or some organization) which does have a vested interest in the outcome. To be heard, the party petitions the court to make an argument. In the Coinbase case, a number of parties have filed as an intervenor (a party who had not been specifically named in the original summons but asks to participate) or amicus curiae.

The Competitive Enterprise Institute (CEI), founded in 1984, describes itself in court documents as “a public interest organization dedicated to protecting limited government and individual liberty.” The CEI notes that it does not have a direct interest in the case but rather “has extensive experience with the subjects addressed in their amicus curiae brief – such as the role of virtual currencies, the privacy and property implications of broad government data demands in the information age, and the use and misuse of government subpoenas.”
Coin Center describes itself in court documents as an “independent, non-profit research center focused on the public policy issues facing digital currency technologies such as Bitcoin and others.” Its experts have testified before Congress on issues including the consumer-protection and national-security implications of digital currencies and it works with the bipartisan Congressional Blockchain Caucus (yes, such a thing exists) to educate members about evolving digital-currency and blockchain technologies.

The DCLDC is a 501(c)(3) non-profit organization. It describes itself in court documents as an organization “that protects individual constitutional rights and civil liberties as they relate to digital currency (e.g., bitcoin) and its related blockchain technology.” DCLDC members are academics and attorneys (you can find a list here) with extensive digital currency and blockchain technology legal experience.

All of the parties argue that the subpoena sought by the IRS in an effort to identify and obtain Coinbase customer information is an overreach.

The original matter began in November of 2016 with a request filed on behalf of the IRS to serve a “John Doe” summons on all United States Coinbase customers who transferred Bitcoin, a convertible virtual currency, from 2013 to 2015. A “John Doe” summons is an order that does not specifically identify the person but rather identifies a person or ascertainable group or class through their activities. The IRS argued that the “John Doe” summons was necessary because they had found evidence of noncompliance and underreporting among Coinbase customers – the agency just couldn’t identify the exact identities and scale of the problem without more information. The IRS was initially seeking all records, including third party information, related to Bitcoin transactions conducted by U.S. Coinbase customers over the 2013 to 2015 time period.

The initial request was granted and in response, Coinbase customer and attorney Jeffrey K. Berns, the Managing Partner of Berns Weiss LLP, filed a motion seeking to be named an intervenor and argued that the ruling should be set aside, and the summons should not be issued. The IRS responded with a motion asking the court to deny Berns the right to intervene. The IRS argued, in part, that since Berns had “outed” himself as a Coinbase customer, he was no longer subject to the summons, making Berns’ motion moot. Eventually, Berns withdrew his motion to intervene, and in March of 2017, the IRS filed a new action seeking to enforce the summons on Coinbase.

Coinbase also argued against the subpoena, as have several “John Does.”

The IRS eventually narrowed the scope of its request and is now seeking information for Coinbase users with at least the equivalent of $20,000 in any one transaction type (buy, sell, send or receive) in any one year during the 2013-2015 period. The IRS has also agreed not to seek records for users for which Coinbase filed forms 1099-K during this period or for users whose identity is known to the IRS.

Those changes meant that the records belonging to John Does 1 and 2 were no longer covered by the summons and they cannot intervene. John Doe 3 was unable to determine if his records are covered by the narrowed summons, so the court denied his motion to intervene but did so without prejudice. That means that John Doe 3 could make a new request to intervene if he later determines that he would be affected by the narrowed summons. However, John Doe 4 could demonstrate to the court that his Coinbase records are covered by the narrowed summons. In July, “John Doe 4” was granted the right to intervene in the matter. The Judge’s Order found that “John Doe 4” made a “sufficient showing of abuse of process to support intervention as of right.”

In its defense of the subpoena, the IRS argued in its most recent filings that:

There has been an explosion of billions of dollars of wealth in just a few years from bitcoin, a significant amount of which has no doubt accrued to United States taxpayers, with virtually no third-party reporting to the IRS of that increase in income.

The IRS also scoffed at the argument that “Bitcoin and blockchain are high regulated technologies,” writing:

In fact, the case of bitcoin exchanges is quite analogous to that of barter exchanges in the “Wild West” days of the late 1970s and early 1980s, before Congress imposed reporting requirements on these barter exchanges. In that time, like currently with bitcoin exchanges, the IRS’s only real recourse to investigate the improper tax reporting suspected to be occurring with these exchanges was to issue John Doe summonses to barter exchanges around the country.

There are state-level regulations in place in a number of states, but some states have excluded digital currency activities from those requirements. There is, argues the IRS, no federal-level requirement to track bitcoin and other digital currency, and no third-party reporting requirement for tax purposes. This means, claims the government that “bitcoin is anonymous in the sense that all parties to that transaction are anonymous to each other and to anyone scrutinizing the blockchain, which has been referred to as “pseudo-anonymity.”

The IRS went on to cite testimony from Senior Revenue Agent Utzke claiming that tax compliance is far higher when there is third-party reporting. According to that testimony, a recent study found that the overall rate of underreporting for taxpayers whose income was not subject to third-party reporting was 63%, compared to only 7% for those taxpayers subject to third-party reporting but not withholding, and a more respectable 1% for those taxpayers subject to both information reporting and withholding.

(You can read more on taxation of cryptocurrencies like Bitcoin here.)

The IRS also argues that some users of cryptocurrency “have openly acknowledged they consider using bitcoin in order to avoid tax reporting requirements.” How does the IRS purport to know this? Online activity. I’ve written about the dangers of posting about your tax avoidance online but years later, message boards are still a magnet for those posting declarations such as “I didn’t pay capital gain tax on bitcoin sales to IRS today.” Pro tip: If other users can see it, so can IRS.

As for privacy? The IRS suggests that the arguments against providing user data imply that cryptocurrency users are somehow entitled to a higher degree of privacy than other taxpayers. Coinbase user’s records are not entitled to a greater degree of privacy than those of a bank account or credit card holder’s, argues IRS, averring that “holders of bank accounts and credit cards have the same interests in autonomy, financial security, privacy of activities and priorities, and preserving privileged relationships as holders of Coinbase accounts.” Those requests for records are routinely approved by courts, claims IRS, writing, “There is no reason why Coinbase users should be an exception.”

After responding to the arguments, IRS made its final point: many of these arguments aren’t relevant, they claim, because the Court has already found that the IRS had a reasonable basis for the issuance of the subpoena. Writing that there has been no additional evidence introduced by third parties and that the arguments raised by third parties offer no grounds to change the initial order, the government asked the Court to enforce the summons request.

The case, United States v. Coinbase, Inc. (3:17-cv-01431-JSC), is assigned to Magistrate Judge Jacqueline Scott Corley in the U.S. District Court, California Northern District (San Francisco).

Technology has changed the way that we think about money. On August 1, the way we think about money may change again following a potential shift in the blockchain world when a so-called “fork” takes place. What this means in simple terms is that two blockchains – and two currencies – could result, causing tax headaches for some users.

(You can read more about the fork here.)

At a specified time, supporters of the new currency, called Bitcoin Cash, will try to break from the main chain and begin operating on their own terms. And here’s where things get tricky. Not all bitcoin trading platforms and exchanges support the move, including big names like Coinbase, which released a statement on its support site, saying:

In the event of two separate blockchains after August 1, 2017 we will only support one version. We have no plans to support the Bitcoin Cash fork. We have made this decision because it is hard to predict how long the alternative version of bitcoin will survive and if Bitcoin Cash will have future market value.

(You can find more about Bitcoin Cash here.)

While tax consequences from the sale and trade of bitcoins vary around the world, U.S. taxpayers must treat bitcoins and other “convertible” virtual currency as capital assets and not as currency. Internal Revenue Service (IRS) guidance released in 2014 (downloads as a PDF) made clear that capital gains rules apply to any gains or losses following a taxable event.

That treatment does have an upside for some taxpayers since capital gains rates are generally favorable. This year, for example, capital gains rates for long-term gains (those held for more than a year) range from 0% to 20%. And losses really are losses: capital losses can be netted against capital gains and the excess losses can be deducted from ordinary income (up to $3,000 each year).

(For more on the tax treatment of bitcoins and other “convertible” virtual currency, see this prior article.)

A taxable event occurs whenever bitcoin is traded for cash or other currency, or whenever bitcoin is used in a reportable transaction like purchasing goods or services. The IRS doesn’t require third-party reporting for virtual currency (yet) so there’s no form 1099-B or equivalent issued at the end of the year. However, some companies like Coinbase will offer a summary of transactions which can be used to help you file your taxes.

But what happens if you take bitcoins out of an account on a platform or exchange? The platform or exchange can no longer track when happens to the coins which means that they can’t help you with reporting. That should make sense: it’s the same as taking money out of your bank. For that reason, cashing bitcoins out of a platform or exchange is typically treated as a sale.

In a situation like this one – where the platform won’t support the currency anymore – you must withdraw it. Coinbase specifically advises that following the fork, “customers with Bitcoin stored on Coinbase will only have access to the current version of bitcoin we support (BTC). Customers will not have access to, or be able to withdraw, bitcoin cash (BCC).”

The access part is key. Just because you don’t have access to Bitcoin Cash after a certain date doesn’t mean that you didn’t have control over it at some point. For tax reasons, continued possession doesn’t necessarily affect whether it’s taxable but the ability to take control over the asset at some point does affect whether it’s taxable.

Think about it like this. Let’s say that your boss gives you a paycheck and you put it in your desk drawer – and then you quit and forgot about the check. You still got paid. The check is still taxable to you even if you never take steps to cash it (such as replacing the check). That principle is referred to as “constructive receipt” and it means that you are taxed on income when it’s made available. You cannot avoid taxation by giving your paycheck to another person, squirreling away checks and not cashing them or mailing them back to your employer. The IRS likes to say that a taxpayer may not “turn his back on income” in order to avoid tax.

There are some exceptions to the rule and they could apply here, based on facts and circumstances. If, for example, you can prove that you didn’t have the power to take possession of the income, or that your ability to take possession was blocked or limited, you may be able to argue that no tax is attributable to you. Fortunately, there is case law that favors taxpayers in these cases though not directly targeted to digital currency.

It’s likely the case, however, that most users of Bitcoin Cash are paying close enough attention that they know they need to withdraw their bitcoins from platforms and exchanges which do not support the currency. That doesn’t mean their tax worries are over. If you’re required to manage your own bitcoins, that also means you’ll be responsible for tracking the basis (meaning cost at acquisition) and the selling or transfer price. And since timing matters, you’ll also be required to track the dates of acquisition and disposition – that means keeping excellent records. In that way, you’re on your own.

If that sounds like an easy way to justify taking a pass on reporting for tax purposes, don’t be tempted. The IRS has been cracking down on virtual currency reporting. The most recent efforts to force Coinbase to turn over customer records means that the agency has been doing a little digging. And it hasn’t been pleased with the data: In 2016, only 802 individual tax returns out of the 132 million filed electronically with the IRS reported income related to cryptocurrencies. That interests IRS since Coinbase alone boasts 8.9 million customers (granted, not all of them are in the U.S.).

What this means is that IRS is likely to make reporting virtual currency transactions for tax purposes a compliance priority. Stay ahead of the game by making sure your records and tax reporting are above-board, no matter what happens to blockchain.