If you are one of the thousands of taxpayers who received a letter from the IRS this summer to inform you of your tax obligations related to virtual currency, it should come as no surprise that the IRS is ramping up their efforts to enforce laws in this area. If you haven’t been contacted by the IRS but are using crypto currency in some form, then be prepared this tax season to claim your activity on your freelance tax return.
According to early drafts of the 2019 individual tax return form (Form 1040) released by the IRS, taxpayers will be required to check a box if they have actively used virtual currency during the tax year. This is the specific question (subject to being changed by the IRS) that you are likely to be required to answer on your tax return: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
All of this IRS activity is a sure sign that any crypto currency activity is going to receive a higher level of scrutiny beginning in the 2019 tax season. In addition, the agency has released updated guidance related to hard forks and air drops of virtual currency as well as new crypto currency FAQs.
These new updates should help you fine tune your understanding of these basic virtual currency tax rules:
- Crypto currency is not treated like cash. It is treated like stocks, bonds, and other investment properties. You need to report your holdings, gains, and losses on Form 8949 and 1040 Schedule D at tax time.
- When you trade crypto currency to crypto currency (calculating its fair market worth in US dollars) or to a fiat currency like the dollar it is a taxable event. It is also a taxable event when you use crypto currency to purchase goods and services. You may also end up owing sales tax.
- Buying crypto currency with U.S. dollars is not a taxable event because you are not realizing gains when you do so. If you trade one type of virtual currency to the same kind in a wallet-to-wallet trade you may not obligated to pay tax, but you do have to account for it, depending on the exchange you are using. Make sure to check the tax rules of the specific exchange and the IRS accordingly.
- Gift tax rules apply if you give crypto currency as a gift that is larger than the annual exclusion amount, which is $15,000 for 2019. The recipient inherits the cost basis and will owe tax when they sell or trade it.
- If you are mining and using virtual currency as a business the general rule is that you must account for the dollar value of the coin at the time you received it and again when you trade it or use it. If you make a payment in crypto currency you must report it as well. If you receive a payment in crypto currency for your business, it is a taxable event. The rules for businesses are complex, so consider seeking the advice of a tax professional to help you.
- You must keep track of your gains and losses each year and deduct this from your cost basis. This makes it vital to keep track of the value of any trades you make in U.S. dollars at the time of the trade.
In addition to proactively providing clarification to taxpayers about virtual currency tax obligations, the IRS is also retroactively looking into virtual currency transactions to identify taxpayers who may have failed to report income from them. If you are part of this group, you’ll need to act now, amending any outstanding tax returns and paying the tax you owe as soon as possible to avoid fines, penalties or legal action by the IRS.
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He offers a free consultation to members of Freelancer’s Union* and a monthly email newsletter covering tax, accounting and business issues to freelancers on his website, http://www.cpaforfreelancers.com— which also features a new blog, how-to articles, and a comprehensive freelance tax guide.
*Jonathan is happy to provide an initial consultation to freelancers. To qualify for a free consultation you must be a member of the Freelancers Union and mention this article upon contacting him. Please note that this offer is not available March 1 through April 18 and covers a general conversation about tax responsibilities of a freelancer and potential deductions. These meetings do not include review of self-prepared documents, review of self-prepared tax returns, or the review of the work of other preparers. The free meeting does not include the preparation or review of quantitative calculations of any sort. He is happy to provide such services but would need to charge an hourly rate for his time.