Bitcoin Tax Laws Explained

By Crypto Tax Attorney Alex Gluzman

 

 

Crypto Tax Compliance

As more and more Americans are investing in crypto currencies, our tax attorneys have unfortunately seen an epidemic of tax issues arising from people either misreporting their crypto earnings, or simply failing to pay taxes at all. 

If you are worried that you may owe Bitcoin taxes and are wondering about the consequences of an audit, you should take your concerns seriously: the IRS is now aggressively pursuing Americans who owe money from virtual currency trades and will likely make examples of those who fail to declare earnings from crypto transactions. Thousands of IRS letters have been sent to crypto traders advising them that their taxes may have been incorrectly filed. Harsher letters were also sent to certain individuals, stating that the filer definitely reported the wrong amount to the agency. 

Former federal tax prosecutor, Kevin. F. Sweeney, said that failing to pay Bitcoin taxes or report crypto currency gains may have serious consequences. Sweeney said that the IRS has been very decisive in its intent to pursue non-compliant taxpayers. 

Our tax attorneys suspect that this campaign may be an offshoot of the 2017 federal court battle between the IRS and Coinbase–a California-based digital currency platform that “banks” your cryptocurrency.  Coinbase, after losing the year-long court battle, was ordered to turn over information to the IRS on approximately 13,000 accounts. The Coinbase court battle is a good example of how tenacious the IRS has become regarding the collection of Bitcoin tax.

If you have received an IRS letter or believe you are on the agency’s radar regarding unreported gains from sources such as Bitcoin, Ethereum or Litecoin, it is in your best interest to contact a tax lawyer as soon as possible.

Bitcoin Tax Reporting Obligations

 

The IRS has issued detailed information to help taxpayers comprehend their reporting obligations for crypto transactions. This new guidance includes Revenue Ruling 2019-24, which is an expansion on notice 2014-21. The information addresses frequently asked questions by consumers and tax preparers concerning Bitcoin tax and situations where filers are holding virtual currency as capital assets.

The mandatory reporting threshold for crypto currency gains is greater than $20,000 for the tax year or the completion of more than 200 receipt transactions. If you are in this category and have not paid Bitcoin taxes, you could face interest, penalties, an audit or other, more serious tax consequences

According to a Coindesk report, some crypto currency investors found out about tax obligations the hard way. They received correspondence from the IRS stating that they owed substantial sums because they either failed to report crypto gains or reported them improperly. 

One taxpayer was told that nearly $4,000 was owed for the 2017 tax year. Another recipient of an IRS letter had reported zero crypto revenue, which may have simply been due to the abrupt value drops commonly seen with Bitcoin. Nevertheless, his letter stated that he owed taxes on $12,000 worth of virtual currency transactions. Many tax lawyers regard these letters as the beginning of a major IRS crackdown on unreported virtual currency gains. Failure to meet these reporting obligations can lead to a 20% penalty or a 75% civil penalty and criminal charges if you are convicted of tax fraud or evasion.

It’s important to understand that the IRS does not regard crypto currency as actual currency. Rather, it is taxed as property, just like your home or your stocks. Subsequently, it is subject to a capital gains tax of 10-37% if it was sold after its value grew. The exact percentage depends on how long you held the virtual currency. 

Ultimately, you must disclose the amount paid for the crypto currency and the value of the services or products for which it was traded every time you complete a transaction. Capital gains taxes are owed if your crypto currency’s value was higher when you bought something with it than it was when the “currency” itself was initially purchased.

Making Sense of IRS Letters 6174-A, 6174 and 6173

As previously mentioned, the IRS has sent thousands of letters to taxpayers pointing out potential reporting errors and the need for corrective action. If you have unpaid Bitcoin taxes, you may have already received one of the following:

Letter 6174 says the IRS believes you have unreported transactions or did not report crypto currency transactions correctly, but this letter more or less assumes that you made a mistake and gives you a chance to correct the problem.

Letter 6174-A states that the IRS is aware that you have virtual currency accounts and it outlines the reporting obligations and taxation guidelines for crypto currency. The letter tells you to take quick action if your returns have not been filed on time or if you believe there are errors on your prior returns regarding virtual currency. 

You may also receive the more severely worded Letter 6173, which states in fairly distinct terms that the IRS knows you have one or more crypto currency accounts and have not reported your gains, as opposed to the wording of letter 6174, which says that you “may not know the reporting requirements.”  

As you can see, the letters range from the agency believing you have virtual currency and possibly had a number of transactions, to knowing you have such accounts and did not report taxable gains. If you have received such a letter or suspect you are about to, it is unwise to proceed without the help of a tax expert. 

 Why You Need a Tax Attorney

If the IRS contacts you, you should obviously attempt to do what their correspondence directs. However, the most important step of all is to get in touch with one of our tax attorneys who can evaluate your options and help you to create a tax resolution plan. Getting legal advice about staying compliant is the best way to avoid audits, penalties or even criminal charges. Never ignore letters from the IRS, as such problems do not go away on their own. Call one of our experts at your earliest convenience to request a case evaluation and get the help you need to resolve any IRS troubles you are facing.

Frequently Asked Questions

How is Cryptocurrency’s Fair Market Value Determined?

With regard to United States taxes, cryptocurrency must be reported in American dollars. For this reason, filers must determine the virtual currency’s fair market value in United States dollars at the time of the payment or receipt. If it is listed on an exchange that establishes the rate by market supply and demand, the cryptocurrency’s fair market value is determined by converting it into American dollars, or into another tangible currency which can then be converted to U.S. dollars in a consistent manner at the appropriate exchange rate.

Are Virtual Currency Payments Subject to Information Reporting?

Payments made with Bitcoin or other cryptocurrency are subject to information reporting just like any other payment made in property. For instance, if an individual who, in the course of business or a trade, submits a payment through the use of cryptocurrency of $600 or more to a nonexempt U.S. recipient, he or she must report the payment to the payee, as well as to the IRS. Examples of such payments include:

 

  • Compensation
  • Annuities
  • Premiums
  • Wages
  • Salaries
  • Rent
Is Virtual Currency Paid to an Independent Contractor Considered Self-Employment Income?

Yes, the virtual currency’s fair market value when received for services rendered by an independent contractor and measured in U.S. dollars is indeed considered self-employment income. Therefore, it is subject to self-employment tax.

Are Taxpayers Subject to Penalties for Having Treated a Crypto currency<br /> Transaction in a Way That was not Consistent with the March, 2014 IRS Notice?

Yes. Penalties may apply to such taxpayers. For instance, underpayments that can be attributed to crypto currency transactions may be subject to specific interest and penalties. Additionally, failure to correctly report virtual currency transactions by the required deadline may result in information reporting penalties under sections 6722 and 6721. However, if reasonable cause can be shown why improper filing or underpayment occurred, taxpayers may qualify for penalty relief.