- 1 Cryptocurrency Tax Audit
- 2 Exchanging Crypto is Taxable Event
- 3 Selling Crypto leads to Cryptocurrency Tax Audits
- 4 Did You Receive Cryptocurrency as Employment Income?
- 5 Are Cryptocurrency Hard Forks and Airdrops Taxable?
- 6 1031 Tax-Deferred Treatment & Cryptocurrency Tax Audits
- 7 Unreported Cryptocurrency?
- 8 Golding & Golding: About Our Tax Law Firm
Cryptocurrency Tax Audit
Cryptocurrency Tax Audit: The IRS tax laws involving cryptocurrency continue to evolve. In general, the U.S. tax laws involving the taxation of cryptocurrency can be very complicated. This is primarily due to the fact that the Internal Revenue Service treats cryptocurrency as property, even though it is generally thought of as currency. Moreover, cryptocurrency tax enforcement is on the rise as well. Even the updated Draft 1040 for 2020 includes a question about cryptocurrency on the first page of the form. Whether or not you received an IRS Letter 6173, 6174 or 6174-A, you may be at a risk for an IRS cryptocurrency tax audit. This is further amplified if you maintain cryptocurrency at Coinbase, due to the court approval (after several rounds) of the IRS Summon for more than 14,000 account holders.
Here are 5 things to know about cryptocurrency tax audits:
Exchanging Crypto is Taxable Event
The U.S. government treats cryptocurrency as property for purposes of federal tax.
This is important because it will impact how the tax rules are applied for the exchange of cryptocurrency and everyday situations.
Here is an example: Let’s say you wanted an asset that your friend Michael owns, that has a FMV of $10,000.
You exchange your $8,500 bitcoin, for his $10,000 asset.
From the IRS’s perspective, you “received” an asset worth $10,000, but you only “put up” $8,500.
Therefore, the property in your hand now is worth $10,000 (FMV on that date) — and you made $1,500.
This is not a “gift” so the carryover basis rules do not apply.
And, even though no money was exchanged, you are taxed on the $1,500 gain.
This is important, especially as the values increase, because you want to make sure you have some liquidity when tax-man (or woman) comes knocking.
Selling Crypto leads to Cryptocurrency Tax Audits
Oftentimes, the income generated from cryptocurrency will come as a result of capital gains.
For example, Jennifer purchased cryptocurrency worth $80,000, which is now worth $600,000.
She wants to sell the cryptocurrency for fair market value (FMV), but wants to know how she’s going to be taxed.
The capital gain sale is equivalent to any other asset sale.
In other words, if Jennifer’s adjusted basis is $80,000, and she sells the cryptocurrency for $600,000, and she has $520,000 of gain.
If the gain is short-term gain, she’ll be taxed at her progressive tax rate, and if the gain is long-term capital gain, she will be taxed at either 15% or 20%. These of taxable transactions oftentimes can lead to a cryptocurrency tax audit when the underlying transaction is not reported properly.
Did You Receive Cryptocurrency as Employment Income?
If you receive cryptocurrency as income, that crypto is reportable as ordinary income, and taxed as income.
For example, if you are a consultant and one of your clients paid you for services in cryptocurrency, then that income is taxed as self-employment income on your tax return.
On the flip-side, the employer/customer would deduct the expenses of paying you just as if they were deducting payments for services or wages.
The employer would not deduct it as a “sale,” but rather as an expense.
Are Cryptocurrency Hard Forks and Airdrops Taxable?
Revenue Ruling 2019– 24 provides some clarifications involving how cryptocurrency is taxed.
The ruling presented two main issues:
- If a person owns cryptocurrency, and then a hard fork occurs (similar to a US stock split), is there taxable income?
- What about if a person receives airdrops in accordance with the hard fork?
While the ruling is very long, the general finding is that a plain hard fork would not result in taxable income, since the hard fork did not result in a taxable event.
But, if the taxpayer also receives airdrops of new cryptocurrency in accordance with the hard fork, then something was gained (airdrops) and therefore the airdrops are taxable income.
1031 Tax-Deferred Treatment & Cryptocurrency Tax Audits
1031 is deferred tax treatment for certain exchanges of certain like-kind property.
While you can try to make the argument to the IRS that the 1031 rules should apply (at least pre-2018), if you were audited, you are looking at a steep uphill battle.
About 1-2 years ago, the IRS stated it would not be developing a “stand-alone” cryptocurrency voluntary disclosure program (at least at that time).
If you are out of cryptocurrency tax and reporting compliance, you should consider domestic or offshore voluntary disclosure.
Golding & Golding: About Our Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS disclosure & compliance.
Contact our firm today for assistance.