How Does Bitcoin and Other Cryptocurrency Affect Tax Planning?

Bitcoin is a form of cryptocurrency, also referred to as altcoins or digital currency. Cryptocurrency was first introduced in 2009 when bitcoin was created. Bitcoin continues to be synonymous with digital currency, even though other forms of digital currency now exist, including Litecoin, Ripple, and Ethereum.

More and more individuals are investing in cryptocurrency and using it for online payments. However, one issue that has arisen in the past decade is the treatment of digital currency for tax purposes.

Is Bitcoin Property?

It can be difficult to view bitcoin and other forms of digital currency as an asset because it is not tangible. Digital currency does not require bank accounts or financial institutions to transfer or back the currency. All cryptocurrency transactions are recorded on a blockchain. Blockchain is a digital public record. Owners use an encryption key to access, transfer, and spend their bitcoin and other digital currency. Without the encryption key, the “coins” are worthless because no one can access them.

If the currency exists solely online, how is it property?

Regardless of whether you can hold bitcoins, the Internal Revenue Service (IRS) views cryptocurrency as property, like a vehicle or real estate. The IRS expects taxpayers to report transactions involving cryptocurrency so that it can apply the section of the tax code that covers the digital currency. If any government agency could figure out a way to produce revenue from bitcoin transactions, it would be the IRS.

How Does the IRS Tax Bitcoin?

Cryptocurrency may be taxed as income for the owner or as a capital gain or loss. The type of transaction dictates how the bitcoin is taxed.

If you are spending, trading, or exchanging cryptocurrency, the transaction may result in a capital gain or loss. A capital gain could increase your tax liability, while a capital loss could decrease your tax liability.

However, several transactions are treated as income for tax purposes. In general, mining and airdrops are considered income for the owner. Receiving bitcoins or cryptocurrency as payment for services and products is also income as is initial offerings.

It is important to correctly identify the type of digital currency transaction to ensure that you report the transaction correctly on your tax return. Incorrectly reporting a bitcoin transaction could result in overpaying or underpaying your tax liability.

Maintaining detailed, complete, and accurate records can help you track bitcoin. Remember, more information and documentation are better. If you are audited by the IRS, having substantial documentation to prove the transaction can keep you out of tax trouble.

Do I Need to Self-Report Cryptocurrency Transactions?

You may or may not receive a 1099 for transactions involving digital currency. Because many people dealing with bitcoin and other cryptocurrency do not issue tax documents, it is best for you to self-report the digital currency transactions on your tax returns. Failing to report taxable transactions could result in significant fines, interest, and penalties. You could owe much more for failing to report a taxable bitcoin transaction than you would have owed had you reported the transaction.

If you are unsure how you should report a cryptocurrency transaction or whether you need to report the transaction, seek the advice of a tax professional. Cryptocurrency can be a lucrative investment, but it can also cost you thousands of dollars if you do not understand the tax implications of bitcoin transactions.

The CJ Berry Group is Your Firm for Holistic Wealth, Estate, & Tax Planning

Dealing with tax matters can be confusing. However, tax planning is an essential element of other financial plans, including your retirement and estate plans. The CJ Berry Group offers classes and individual counseling to help you learn more about holistic financial planning.

If you have questions or desire more information, contact our office by calling (844) 885-4200. A friendly, knowledgeable member of our staff will be glad to assist you.