As income tax season approaches, Americans prepare to pay their taxes and file their returns. This is also the time to begin the work of maintaining new records for the following fiscal year. In the midst of all the developments, the participants who dealt in cryptocurrencies As bitcoins are very worried.
In 2017, the Tax Service (IRS) ordered on Coinbase cryptocurrency exchange to transmit all necessary data related to transactions made by more than 14,000 of its customers who bought, sold, received or sent more than $20,000 worth of bitcoins (BTC) between 2013 and 2015. Those who suspected then that Uncle Sam was willing to review and levy necessary taxes and penalties on bitcoin transactions were right. On July 26, 2019, the federal agency announced that it would send educational letters to 10,000 taxpayers it suspects “of potentially failing to report income and pay taxes resulting from virtual currency transactions or not having correctly declared their transactions”.
“Taxpayers should take these letters very seriously by reviewing their tax returns and, if necessary, amending previous returns and reimbursing taxes, interest and penalties,” said IRS Commissioner Chuck Rettig, in a press release. “The IRS is expanding its efforts around virtual currency, including the increased use of data analytics. We are focused on law enforcement and helping taxpayers fully understand and meet their obligations.”
While these developments may have come as a surprise to some cryptocurrency proponents, it is important to realize that taxes are imminent, regardless of the nature of transactions and asset classes.
Let’s look at some important tips that will help prepare tax returns for filers who have bought or sold cryptocurrencies.
Bitcoin record keeping is your responsibility
There are hundreds of brokers, intermediaries, and exchanges that offer cryptocurrency trading. However, none are required to provide tax returns to market participants, although a few may do so at their own discretion. For example, Coinbase provides a “cost basis for taxes” report.
Ultimately, the individual is responsible for maintaining the necessary records related to their cryptocurrency transactions.
Let’s say six months ago you bought 10 bitcoins at the rate of $3,000 each or maybe you received them as payment for work you did for a client. Today, these bitcoins can be worth $9,000 each, bringing your potential profit to $6,000 per coin.
It is your responsibility to have the necessary documents showing that you received them at the time they were worth $3,000, and therefore your net income is $6,000 per coin. If you don’t keep this transaction data and documentation, your holdings could be valued at the present value of $9,000 each, significantly increasing your tax burden.
Any bitcoin transaction may be subject to tax. Suppose you received five bitcoins five years ago, spent one in a cafe four years ago, spent another two to purchase goods from an online portal three years ago, that you sold the other two and got the equivalent dollar amount a month ago. For each of these transactions on different dates, you must maintain the equivalent dollar value for each and calculate your net dollar income from bitcoins. Your tax payable will be calculated accordingly.
Understanding Bitcoin Taxation
To properly maintain records, it is important to understand how different cryptocurrency transactions are taxed. Depending on the type of bitcoin transaction, here are the different scenarios to keep in mind for tax preparations:
If bitcoins are received as payment for the provision of goods or services, the holding period does not matter. They are taxed and must be reported as ordinary income using fair market value on the date of the transaction. The federal tax on this income can vary from 10% to 37% marginal tax rate. In addition, there may be income taxes to pay.
If bitcoins are received from mining activity, they are treated as ordinary income. Additionally, there may be a self-employment tax payable on these receipts.
If bitcoins are bought as an investment and sold at a profit, the treatment of this income depends on the holding period. If held for less than one year, net receipts are treated as ordinary income which may be subject to additional state income tax. If the holding period is longer than one year, it is treated as a capital gain and may result in an additional 3.8% tax on net investment income.
Account for Bitcoin Tax Cuts
If you have donated your cryptocoins, such as bitcoin or ethereum, to qualifying charities, then you may qualify for a tax reduction.
For example, in 2017, the Fidelity Charitable fund received bitcoin donations worth approximately $69 million. The working mechanism of the charity fund ensures that the bitcoins received are immediately sold on the Coinbase exchange. The dollar amount received from such a sale is invested according to the choice of the donor, who benefits from it by benefiting from a tax deduction in the year of the donation.
However, care should be taken that only donations of cryptocurrencies made to eligible charities qualify for such deductions. Selling the tokens and then donating the dollar amount will not reduce your bitcoin tax burden. Additionally, deductions are available to individuals who itemize their tax returns.
Provisions for cryptocurrency losses
Similar to tax rules for equity investments, cryptocurrency losses can be used to offset capital gains, subject to certain rules, and losses that are not used to offset gains can be deducted – up to to $3,000 – other types of income. The rules also contain loss carry-forward provisions.
Declaration of Bitcoin income
Income from bitcoin transactions must be reported in Programwhich is an attachment of Form 1040.Depending on the type of transaction that determines the type of income from cryptocurrency (ordinary income or capital gain), the income should be reported under the correct heading in the appropriate columns of the form.
While the IRS released its first set of guidelines and rules in 2014, less than 900 people reported capital gains or losses related to Bitcoin trading between 2013 and 2015. As the IRS begins to crack down on taxation of cryptocurrenciesit is important that individuals keep records of their transactions and remain prepared for any scrutiny, payment of taxes and possible penalties.
Investing in cryptocurrencies and other initial coin offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the author to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decision. Investopedia makes no representations or warranties as to the accuracy or timeliness of any information contained herein.
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