Investing in Bitcoin? Buckle Your Seatbelt-and Remember the IRS

As we go to press, the value of a bitcoin, which entered 2017 at less than $1,000, is poised above the $17,000 mark.

Reports on this spectacular rise might have you getting your feet wet with virtual currency. With bitcoin futures already available to traders, and the Chicago Mercantile Exchange having announced the December 18th opening of trading, it's clear that Bitcoin has arrived in the professional sphere.

Should you decide to jump in, you might first wonder what your spouse or significant other will think. But what will the IRS think?

The short answer is simple: The IRS will expect a declaration of your earnings (or losses) on Form 1040, Schedule D.

The IRS Treats Bitcoin as Property, Not Currency

In 2014, the IRS defined Bitcoin and other virtual currency as property. Accordingly:

  • Paying anyone with virtual currency should be reported, as expected whenever your property becomes a payment. 
  • If you pay anyone their wages in Bitcoin-yes, some people do-the worker pays the tax, and you report the payment on a Form W-2. This makes wages in Bitcoin subject to payroll tax and the IRS tax withholding system. 
  • If you pay a contractor for a service in virtual currency, be sure to issue a Form 1099.

For Bitcoin Earnings, Tax is Lower Than Income Tax

According to the IRS, gains or losses transactions in virtual currency ("cryptocurrency") are taxable to the extent that the currency makes up part of your capital assets.

Taxes on capital gains, at a maximum of 20% for the wealthiest taxpayer (currently), are, as a rule, lower than income tax rates.

Say you earn a salary of $60,000, which puts you in the 25% tax bracket, and you bought your own bitcoin almost a year ago, for $1,000 (your cost basis). And say your investment goal was to double your value, then sell. After the Bitcoin doubled in value, you sold-realizing a gain of $1,000. As you held your Bitcoin less than a year, your short-term gain, at your tax bracket's 25% rate, means you owe the IRS $250.

Alternatively, say you're still hanging onto that Bitcoin. Great! As of today you're sitting on a $17,000 Bitcoin, and once you've held it for more than a year, whatever you make when you sell will be classified as a long-term gain, taxed at only 15%.

IRS Comes Knocking as Retail Buyers Fail to Report

Today's main retail exchange for virtual currency is a startup called Coinbase, which major venture capital players have backed with more than $200 million. It's a bustling, easily entered market, and many of the platform's users haven't yet figured out that virtual currency is taxable. 

The Internal Revenue Service launched an investigation into customers who bought and sold Bitcoins through Coinbase once the currency's value began its dizzying rise. Coinbase resisted the government's request for information about its customers in federal court, and the IRS narrowed its search down to parties involved in moving $20,000 or more.

Still, the message is clear. Your virtual currency is real enough to the IRS.

Let's say a revenue officer shows up at your door with a 433-A. He/She will ask about your financials, but how do you answer for your Bitcoin investment? Do you know your rights? You can decline to answer and let Travis W. Watkins Tax Resolution and Accounting Firm take the weight off your shoulders. If you are or plan to invest in Bitcoin our accounting and bookkeeping services will handle all of your financial transactions, while this unfolds. Call us today at 800-721-7054.  

 

 

Travis Watkins
Senior Tax Attorney
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