IRS Crypto Regulations: How the IRS Treats Cryptocurrency
How Does the IRS Classify Cryptocurrency?
As cryptocurrency gains popularity as an investment option, people are beginning to need guidance on how to report cryptocurrency on taxes. Currently, the Internal Revenue Service (IRS) classifies cryptocurrency as property for tax purposes, this means:
- It is not treated as a type of currency
- It does not pay dividends or accrue interest
- It may require an appraisal for estate tax purposes
- The value may fluctuate in the same way as real estate
What are the IRS Regulations Surrounding Cryptocurrency?
The IRS treats all cryptocurrency as a capital asset and taxes them. This means, when you sell your cryptocurrency, like Bitcoin or Ethereum, for a profit the capital gains tax rules apply and you would have to pay short-term capital gains, if you held your cryptocurrency for one year or less, or you will have to pay long-term capital gains, profits earned on cryptocurrency held for one year or longer.
Additionally, if you earn cryptocurrency by mining it, receive it as a promotion or as a payment for goods or services, it will be counted as part of your regular income tax rate. And, if you hold the same cryptocurrency you mined, received as a promotion or as a form of payment, and that cryptocurrency value increases then you would be required to pay capital gains taxes on the profits based on how long you’ve held it.
How Will the IRS Know if You Owe Them Crypto Taxes?
First and foremost, it is important to voluntarily report your earnings from your cryptocurrency investments to avoid future tax audits. You may ask yourself, “If I have to volunteer the information then how would the IRS know I made crypto earnings in the first place?” The answer is that there are three ways the IRS can find out about your crypto holdings.
Form 1099-K & Form 1099-B
Cryptocurrency exchanges in the United States, like Coinbase and Kraken, report to the IRS. If you have more than $20,000 proceeds and 200 transactions in crypto exchanges, you will receive Form 1099-K that documents your proceeds each month from your crypto exchange. Your crypto exchange will also send a copy of that Form 1099-K to the IRS. Once you file a tax return and you neglect to include the amounts from Form 1099-K, the IRS computer system (Automated Underreporter) will flag you for not reporting and you could be subject to tax notices and penalties. Additionally, should you receive Form 1099-B and do not report it, the same principles apply.
Subpoenas
The IRS has issued subpoenas to cryptocurrency exchanges that required them to disclose user information and accounts. Large cryptocurrency exchanges like Coinbase and Bitstamp have been served subpoenas that required the disclosure of information like taxpayer identification numbers, names, birth dates, account activity logs, transaction logs, statements and invoices. If your name is listed in a subpoena, the IRS can match the records to see if you’ve been adequately reporting crypto on your taxes.
Schedule 1 of Form 1040
At the beginning of the 2020 tax season, on Schedule 1 of Form 1040, each taxpayer will be asked to if they receive, sell, send, exchange or acquire financial interest from virtual currency. It is important to be truthful and volunteer this information. And it is possible that you do not owe taxes on your cryptocurrency if you simply held your coins and did not sell them in 2019, for example.
What Are Law Enforcements in Regard to Cryptocurrency?
Law enforcement and other government entities, aside from the IRS, have begun to investigate cryptocurrency for its positives and negatives. In October 2020, the Department of Justice released the Cryptocurrency Enforcement Framework authored by the Attorney General’s Cyber-Digital Task Force. The report identifies legitimate uses for cryptocurrency but also acknowledges how cryptocurrency can be used for criminal acts. The report states, “whatever the overall benefits and risks of cryptocurrency, the [DOJ] seeks to ensure that uses of cryptocurrency are functionally compatible with adherence to the law and with the protection of public safety and national security.” The report then includes categories of how “bad actors” can “exploit” cryptocurrency for wrongdoing: “(1) engage in financial transactions associated with the commission of crimes, such as buying and selling drugs or weapons on the dark web, leasing servers to commit cybercrimes, or soliciting funds to support terrorist activity; (2) engage in money laundering or shield otherwise legitimate activity from tax, reporting, or other legal requirements; or (3) commit crimes directly implicating the cryptocurrency marketplace itself, such as stealing cryptocurrency from exchanges through hacking or using the promise of cryptocurrency to defraud unwitting investors.”
Throughout the report, the DOJ makes it clear law enforcement and federal agencies are within their rights to enforce against a variety of criminal conduct when involving cryptocurrency. Other federal agencies that can enforce statues and regulations against people who use cryptocurrency in illicit ways are: Financial Crimes Enforcement Network (FinCEN), the Office of Foreign Assets Control (OFAC), the Office of the Comptroller of the Currency (OCC), the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the Internal Revenue Service (IRS).
Are There Other Government Bodies Where You Should File Cryptocurrency Transactions?
There are no other government bodies where you should file cryptocurrency transactions. By keeping detailed records of your cryptocurrency transactions, you will report to the IRS:
- Cryptocurrency profit or loss as short-term and/or long-term capital gains
- Virtual currency as a payment is taxable income
- If you mine cryptocurrency it is taxable income
Will There be a Change of IRS Regulation in Relation to Cryptocurrencies?
As for changes in 2020, as mentioned before, the Schedule 1 of Form 1040 asks whether you received, sold, sent, exchanged or acquired financial interest on virtual currency in the year 2019. This may be one of the first changes by the IRS to request reporting cryptocurrency income, but it may not be the last.
In all likelihood, there will be a change to the IRS regulation in relation to cryptocurrency in the future. The IRS has taken steps to document crypto earnings with items such as the Schedule 1 of Form 1040 and legal action like subpoenas to high profile exchanges. This is seen as a progression to take the cryptocurrency landscape seriously and keep a close eye on its earning potential.
Contact Blake Harris Law to Learn More
Blake Harris Law is not a financial institution. This article is intended for educational purposes only and not as tax advice. To learn more about the tax treatment of cryptocurrency, visit the IRS Notice 2014-21, IRS Revenue Ruling 2019-24 and its Frequently Asked Questions.
If you would like to learn more about estate planning or asset protection for cryptocurrency, contact us today by email at info@blakeharrislaw.com or by phone at 833-Ask-Blake. We always start with a free initial consultation and if you later decide to hire us, we would be happy to take payment in several different forms of cryptocurrency.
