Virtual currency, also referred to as digital currency or cryptocurrency, makes it possible for individuals to send or receive payments without using conventional paper currency. Some of the most prevalent forms of virtual currency include bitcoin, litecoin, and ethereum. It’s increasingly common for workers to be paid in virtual currency or for retailers to accept virtual currency as a payment option.
If you own virtual currency, you must take steps to properly report the currency on your tax returns. This guideline applies whether you accept virtual currency for payment or use it as an investment. Otherwise, you open yourself up to multiple actions from the IRS, including but not limited to, tax penalties, interest on unpaid taxes and criminal prosecution for not adhering to the tax code. Here’s what you need to know about reporting virtual currency transactions on your tax return.
How You Report the Virtual Currency Depends on the Specific Transaction
The steps you take to report your virtual currency on your tax return depend on the specifics of the transaction. If you received the virtual currency as payment for work you completed or for retail items that you sold, you’ll report the virtual currency payment as income. To do so, you’ll need to determine the current market value of the virtual currency in U.S. dollars on the date that you receive it. Since the market value of virtual currency varies from day to day (sometimes significantly), it’s essential to keep detailed records regarding your payments.
If you’re a business owner or employer who makes payments using virtual currency, you can typically treat these like you would other business expenses. Again, you’ll use the value of the currency on the date you make the payment for your records. Should you use virtual currency to pay regular employees their wages, make sure you withhold employment and income taxes from the payments.
Some individuals choose to buy and sell virtual currency, much like they would stocks or other investments. You don’t have to report the purchase of virtual currency; however, if you sell the virtual currency for a profit, this needs to be reported on your taxes.
The rules for reporting and paying taxes on capital assets govern the treatment of virtual currency transactions. If you hold the virtual currency for less than a year, it’s treated as a short-term gain and will be taxed at your ordinary income tax rate. Should you hold the virtual currency for a year or more, it’s treated as a long-term gain and taxed at the long-term capital gains rate.
It’s Possible to Write Off Losses Related to Your Virtual Currency
There’s no guarantee that virtual currency will rise in value or even keep its existing value, making it possible to lose money when dealing with virtual currency. Though fluctuations in virtual currency won’t impact you if you accept it for payments (remember, you report the market value on the day you receive it, regardless of future changes in the value), you can deduct losses associated with investing in virtual currency on your taxes.
Since virtual currency is treated by the IRS as a capital asset, you can deduct up to $3,000 in losses each year to offset your ordinary income. You can use losses that exceed $3,000 to offset your income in future years.
To learn more about virtual currency requirements and best practices, contact FAL today at 702-870-7999.