By Judith Herron, CPA
The use of Bitcoin can be tricky from a tax perspective. Actually, it’s not just Bitcoin now. There are more than 700 cryptocurrencies in circulation, and the total market for these digital currencies is estimated to be $50 billion. To date, Bitcoin remains the dominant player with a market cap of more than $30 billion. Regardless of which cryptocurrency you may use, there are details you need to share with your CPA. In the following examples, I use Bitcoin, but the advice is the same for any digital currency.
You Are Getting Paid with Bitcoin: If you get paid in digital currency it is the same as being paid in cash. Your employer will report those payments on your W-2 form. If you are self-employed, payments should be treated like cash. Full payroll taxes and income taxes get paid on digital currency compensation.
You Are Making Bitcoin: If you engage in Bitcoin mining, you would recognize the value of the Bitcoin as income on the date it is awarded on the blockchain. There is an opportunity to offset this income with deductions for the cost of electricity and equipment involved in the mining.
You Are Making Purchases with Bitcoin: If you pay vendors in Bitcoin, it’s like paying with cash, but a little more complicated. You would record the expense as if you were paying cash. If it’s a service you are paying for, and the person charged you $600 or more, you likely should issue a Form 1099-MISC.
How paying vendors with cryptocurrency differs from cash is that the IRS sees the payment as if it were a property transaction. You need to know how much it cost you to get the Bitcoin and how much it was worth when you made the payment. It’s as if you paid a vendor by selling stock.
When you sell stock you calculate the difference between what the stock cost, and how much you sell it for. That change in value becomes a gain or loss that is reported on your tax return. The same thing happens with digital currency. For each transaction you need to track the change in value.
When you trade stocks you get a statement at year-end that provides the information you need to report on your tax return. Digital currency exchanges typically do not provide the same service. There are steps you can take to get your transaction information from the exchanges, and there are websites that promise to help with the calculations.
The fact that exchanges don’t report this information to their customers leads some people to consider the possibility of not reporting to the IRS. But there are some significant problems with not proactively reporting your digital currency activity. The primary problem is that paying taxes on income and gains is not optional. Secondly, there is significant infrastructure in place in the United States to capture indications of cash under-reporting, so your digital currency activity may be more visible than you realize. American banks and Bitcoin exchanges are required to file something called a suspicious activity report with the Treasury Department when cash amounts over a certain threshold ($5,000 for banks, $2,000 for exchanges) are moved in a way that can be deemed suspicious. Speculating in Bitcoins can be lucrative; speculating on getting caught evading taxes can be financially and personally catastrophic.
Cryptocurrency is evolving, and government reporting requirements are adjusting. Make sure you keep your CPA in the loop. Remember, good books and records are your best bet for getting the benefits of this cutting-edge technology without incurring penalties.
Judith Herron, CPA, works at Markovitz Dugan & Associates, a CPA and business consultanting firm in Pittsburgh. Her areas of expertise include business consulting, corporate income tax preparation and planning, financial statement reporting, personal income tax preparation and planning, and tax compliance. She is a PICPA member and is chair of the CPA Image Enhancement Committee.