Cryptocurrency is everywhere.
Millions of people are investing in it. More and more businesses are accepting it and fortunes are being made and lost with it every day. Companies are even putting crypto assets in their IRAs.
Crypto is exciting, and the crypto market is exploding.
If you have not bought or received any crypto yet, odds are you will.
Cryptocurrency is becoming part of everyday life.
There are more than 26,000 cryptocurrency ATMs just in the US. Companies like Walmart and Circle K are installing more every day.
But cryptocurrencies and crypto assets can have huge negative tax consequences if you don’t know what they are and how they are taxed.
For example, most people think cryptocurrency is a currency. It is not.
If you personally buy or use cryptocurrencies – you need a crypto accountant. If you are thinking about accepting cryptocurrency in your business – you need a crypto accountant.
If you are thinking about buying cryptocurrency, NFTs, or any digital assets, you should see a crypto accountant first.
Here’s why.
Cryptocurrencies Are Everywhere
Research shows that about 46 million Americans own or have owned the most famous cryptocurrency, Bitcoin. Between 16% to 22% of US adults have purchase Bitcoin.
That’s more than 46 million Americans, and that is just Bitcoin. There are more than 10,000 different cryptocurrencies, but the top five have 70% of the market, with Bitcoin and Ethereum at 41% and 19%.
There are 300 million cryptocurrency users worldwide, and that number should grow to reach 1 billion by December 2022.
So, whether you invest in cryptocurrency or accept it in your business, you should know what it is and how the IRS taxes cryptocurrency exchanges.
What is Cryptocurrency?
The name cryptocurrency is confusing because this is not a “currency.”
Cryptocurrencies are digital files that are used as money or currency for transactions.
These files use cryptography (the crypto in cryptocurrency) for safety and are stored on a blockchain for security.
A blockchain is defined as “a digital database containing information (such as records of financial transactions) that can be simultaneously used and shared within a large decentralized, publicly accessible network.”
The easiest way to think of a blockchain is like a ledger sheet where you record transactions that can never be erased, edited or altered – ever! Blocks of information are added to the chain and become permanent.
The entire chain and all the blocks are publicly visible for all to see but the details of the transaction are encrypted. Only the parties with a private encryption key can know the private details.
Why Was Bitcoin Invented?
Bitcoin started on October 31, 2008, it was designed for people to do business on the internet without having to trust each other or rely on banks or third parties. Originally, internet buyers and sellers did not trust each other enough to deal directly with payments, so they used banks to process payments.
Banks trusted other banks and processed internet transactions but the banks ended up reversing some charges and had increased costs due to fraud, lawsuits, mediation, and more. So, banks raised the fees to the merchants and to reduce fraud, merchants asked ever-increasing privacy questions from their customers.
Bitcoin is designed to allow two willing parties to directly transact with each other without needing a trusted bank. Bitcoin transactions are protected from fraud because they are recorded on an immutable blockchain. Computer networks make this possible with routine escrow mechanisms that made the transaction “computationally impractical to reverse.”
Banks do not Control Decentralized Cryptocurrency
Banks are centralized, but cryptocurrency is decentralized.
No central banks in any country issue cryptocurrencies. Instead, cryptocurrencies use a digital network to record transactions and issue new “coins.” Although the crypto industry uses the term “coin,” there is no physical coin at all.
The US government does not regulate them as currency or securities at this point. The IRS has clearly defined and taxed them as property, as have most other worldwide government taxing authorities.
And cryptocurrencies are not legal tender in any country except El Salvador, where Bitcoin was accepted as legal tender there in September 2021. In El Salvador, you can pay for gas, groceries, McDonald’s, Starbucks, and Pizza Hut with Bitcoin.
Most world governments are rapidly enacting new laws and regulations as they try and establish control on cryptocurrencies in their countries and worldwide. This includes the US, the IRS, and FinCEN.
Governments view cryptocurrency as an anonymous payment method that can be used for money laundering and illegal activities like drug trafficking, terrorism, and tax evasion.
As one example of increased regulation, in the US, any company that administers or exchanges cryptocurrency is classified as a money service business (MSB) and falls under to Bank Secrecy Act and its reporting requirements.
The IRS and Cryptocurrency
The IRS has been remarkably consistent. They view cryptocurrency as property and not currency for tax purposes.
The IRS calls cryptocurrency as “virtual currency” instead of a real currency like the Dollar, Euro, or Yen, which makes cryptocurrency a digital representation of value.
The IRS definition is “a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.”
When you buy something with cryptocurrency, the IRS views it as an exchange of one asset for another. If you purchase an SUV with one Bitcoin, currently worth about $38,000, you have exchanged one Bitcoin for one SUV. The IRS will tax you as if you traded any other asset for the SUV, like a painting, baseball cards, or a record collection.
Determining Basis and Gain
When you sell or exchange an asset, the IRS taxes you on the “profit” or gain at the time of sale. To calculate your gain, you must know how much you paid for the asset originally
This is easy to do with most assets like stocks or paintings. When you purchase an asset, like artwork, you get a bill of sale or have some record of the purchase. This acquisition cost is treated as your basis.
However, when using cryptocurrency for a purchase, you are taxed at short-term or long-term capital gains rates.
In the example above, if you bought the SUV with one Bitcoin, the IRS wants to know the capital gain of the Bitcoin. If you bought the Bitcoin 2 years ago for $10,000, and are using it now for a $38,000 purchase, you have a taxable long-term gain of $28,000 when you use the Bitcoin.
Keeping Track of Your Crypto Basis Can Be Difficult
Determining the basis of your cryptocurrency can be challenging. Crypto markets often have wild price swings during the day. Unlike the stock market, there are no central listing of value, just listings of average values. Your stockbroker will send you an early Form 1099-B you can file with your taxes.
Until now, crypto exchanges were not required to send 1099-Bs on cryptocurrency accounts.
Starting in 2023, all crypto exchanges are required to send in 1099-Bs to notify the IRS directly of crypto transactions. This was a part of the $1 trillion dollar infrastructure bill enacted into law in November 2021.
The difficulty is that each “coin” is an individual piece of property with a separate acquisition cost and gain. Keeping track for tax purposes is difficult. Many cryptocurrencies’ owners buy their crypto on multiple exchanges and transfer them between multiple crypto wallets.
Buying cryptocurrency is easy. Keeping track of it for tax purposes is not.
While there are several “coin tracking” programs you can use, this is where a qualified crypto accountant can help you keep your records accurate and compliant.
As an example, you might “buy” Ethereum, Doge, or Binance “coins” with your Bitcoin. Then, you might use your Ethereum to buy an NFT or tangible asset. Every coin is unique, and the purchase cost and sale price of every coin needs to be tracked individually.
The IRS knows if you have any cryptocurrency, the reporting obligation is on you.
On the front of your 2021 Form 1040, you must answer the question, “At any time during 2021, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency”.
In addition to the ever-increasing reporting requirement, a crypto accountant can help you reduce your taxes by analyzing when and how you should use your cryptocurrency.
Since your cryptocurrencies are all separate pieces of property, each with a specific purchase price and gain, careful tax planning can help avoid the unpleasant surprise of a huge tax bill – which is common for people using cryptocurrency like cash.
Your Next Best Crypto Step
Cryptocurrencies are here to stay.
Hundreds of millions of people are using them, and more and more businesses accept them as payment and thousands of crypto ATMs are going into convenience stores and other locations throughout the US.
Investing in crypto and accepting crypto payments in your business might be a great strategy to increase your revenue.
But because the IRS treats cryptocurrency as property and not currency, there are huge tax pitfalls if you don’t properly plan and keep track of your crypto transactions.
And there is little doubt that new and more stringent regulations will be coming soon.
So, the question is, how can you use the benefits of crypto and avoid any tax disadvantages?
Let us help as your crypto accountant.
It is almost impossible for anyone to keep up with all the crypto rules and regulations – and you don’t have to.
Your time is best spent growing your business.
We keep up with all the rest for you.
At CE Accounting, we don’t just file forms and crunch numbers. We analyze your business and your business goals to minimize your tax obligations – and cryptocurrency can be a big part of achieving your goals.
Call today and let us show you the next best steps for using crypto for you and your small business.
“This article is not intended to give, and should not be relied upon for, legal tax advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of a qualified professional.”