A New Financial Frontier: Cryptocurrency and Taxes

Cryptocurrency is quickly becoming a mainstay in the world of finance, as well as in the public consciousness. Even so, many cryptocurrency investors might be unaware that they could owe taxes on their investments even though they haven’t cashed them out.

Ignorance of the law is no excuse, and cryptocurrency investors must be aware of their risk of tax evasion. Unlike registered brokers, cryptocurrency exchanges do not provide annual summaries such as 1099-DIV, 1099-INT, 1099-Bs to their investors, nor do they report an investor’s activity to the federal government. In the case of cryptocurrency, reporting annual profits and losses to the federal government is the responsibility of the investor.

How the IRS views cryptocurrency

Cryptocurrency, as defined by the IRS, is any “digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United States dollar or a foreign currency.”

Cryptocurrency is “used” through cashing in, cashing out, and trading between the various exchanges and types of cryptocurrency, similar to stocks. In fact, the IRS considers cryptocurrency to be property rather than anything resembling usable currency, putting cryptocurrency more in line with stocks and real estate.

Similar to stocks and real estate, capital gains and losses should be filed for exchanges in cryptocurrency. This is done through the IRS Form 8949, which is used to reconcile amounts filled out in Forms 1099-B and 1099-S. These two Forms deal with stocks and other commodities (B), and real estate (S). 

As far as Form 8489 is concerned, how long an investor holds cryptocurrency also matters. This is where long-term and short-term gains come into play; short-term gains taxes should be placed on cryptocurrency trades, if that particular cryptocurrency is moved in any way within one year. Long-term gains taxes would come into play if an investor waits more than one year to move that cryptocurrency, and is more favorable than short-term gains, which is equal to basic income taxes.

It may seem wise to hold onto cryptocurrency for longer in order to avoid short-term gains tax rates, but the cryptocurrency market fluctuates dramatically compared to other markets.

Taxable actions

What actually falls into the category of a taxable action in the world of cryptocurrency is broader than might be assumed. Investors should file whenever capital gains or losses occur in cryptocurrency, very similar to stocks or real estate.

In cryptocurrency, however, direct trading between different currencies, known as “converting,” can be done. For example, an investor might move from Bitcoin to Ethereum. Even though no actual currency is received when an individual moves between cryptocurrencies, these movements have to be recorded, and any gains or losses based on the values of the currencies at the time of the trade, do as well. These conversions are taxable in the eyes of the IRS.

Conversion is very common in cryptocurrency, but keeping up with what cryptocurrency is traded is becoming just as important for tax purposes as the monetary amount that goes in/comes out of the process.

Cryptocurrency as payment

Buying, selling, and trading aren’t the only things being done with cryptocurrency. As cryptocurrency has become more and more popular, some have started to use it as a form of payment for services or goods, like any legal tender.

Receiving cryptocurrency as payment for work does not circumvent any income taxes that would accompany a direct monetary payment. The value of the cryptocurrency at the time of payment has to be translated into U.S. dollars for tax purposes in this circumstance. This is known as the fair market value of the cryptocurrency, and it is up to the taxpayer to determine this at the time the cryptocurrency is received.

For example, if someone receives $5,000 in the form of cryptocurrency, then s/he will record and pay income taxes on $5,000, even if that same amount of cryptocurrency sinks to $2,000 at the time of filing taxes.

A new financial world

Governments around the world have had a difficult time tackling just how to address the rapid rise of cryptocurrency. This has led many cryptocurrency investors to the assumption that this is a secretive way to make money with little oversight. But, that system is changing as cryptocurrency matures and becomes more ingrained in the financial world.

It’s time for all cryptocurrency users to start considering the implications of that attention and be aware of their obligations to report their activities as part of their annual tax filing.

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