The IRS has begun sending letters to taxpayers with virtual currency transactions that potentially failed to report income and pay the resulting tax from virtual currency transactions or did not report their transactions properly. By the end of August, 10,000 “educational letters” will be delivered to taxpayers telling them to amend their returns to report their virtual currency transactions. There are three versions of the letter, often called a soft notice — fix the problem or we’ll audit you — Letter 6173, Letter 6174 and Letter 6174-A.
Coinbase Inc. lost its bid in Federal court to stop the IRS from examining its customer records. With just 800 taxpayers reporting Bitcoin transactions from 2013 to 2015, when more than 14,000 Coinbase users bought, sold, sent, or received at least $20,000 of Bitcoin, the information that the IRS gathered produced plenty of audit targets, evidenced by the 10,000 letters.
How is Virtual Currency Taxed?
Notice 2014-21 provided answers to frequently asked questions relating to the taxation of virtual currencies. Also see IR-2018-71 where the IRS reminded taxpayers to report virtual currency transactions.
- Sales. Virtual currency is treated as property for US tax purposes. The general tax principles that apply to property transactions also apply to virtual currency. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer.
- Example. Steve bought 10 Bitcoins for $10,000 in 2010. He sold them in July 2019 for $94,000. He must report the sale on his schedule D as the sale of property. Steve has a long-term capital gain of $84,000.
- Tax practitioner planning. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. Thus, a Form 1099-K is required if the taxpayer has more than 200 transactions or the transactions total more than $20,000.
- Miners. When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income. The fair market value of virtual currency received for services performed as an independent contractor, measured in US dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
IRS Guidance is Coming. . . Soon
After requests from AICPA, Congress and other interested parties, the IRS announced in IR-2019-32 that it anticipates issuing additional legal guidance in this area very soon. There is agreement that guidance is needed on calculating cost basis, lot assignment and virtual currency hard forks.