It’s been estimated that roughly 8% of adults in the U.S. hold some form of virtual currency said Michael Desmond, chief counsel to the IRS in citing industry estimates during his October 2019 speech. This should create a plethora of crypto taxable events, right?
Mr. Desmond went on to explain that based on the 150 million returns the IRS processes annually, they would therefore expect roughly 12 million returns reporting virtual currency transactions. However, he indicated that it was, “nowhere near that” and a very high priority on the enforcement side for the IRS given the estimated high degree of non-compliance.
And a “high priority” it’s been. Virtual currency was included in the 2019–2020 IRS Priority Guidance Plan. New guidance was released in the form of a Revenue Ruling 2019-24 and updated FAQs. But perhaps the most significant act indicative of the elevated priority the IRS has placed on virtual currency is the new question on the top of page 1 of the draft 1040 return for the 2020 tax year.
This is simply an area the tax professional can no longer ignore. On the contrary, it provides a tremendous business development opportunity to provide crypto tax compliance services.
Here are 8 common taxable events that tax professionals and crypto users in the U.S. should be aware of.
This is not intended to be a comprehensive list dealing with potential tax implications relating to crypto activities. Rather, its meant to highlight and provide some basic crypto tax principles based on the IRS guidance published to date for educational purposes.
- SALE of Crypto for Fiat. Selling crypto for fiat (e.g. USD) will be a taxable event. The character of the gain or loss depends on whether the crypto is a capital asset (e.g. stocks, bonds, and investment property) in the hands of the taxpayer and the length of time the position was held. Learn more about this here.
- PURCHASE of Goods or Services with Crypto. If a taxpayer receives virtual currency as payment for goods or services, it should be included in gross income at fair market value on the date of receipt. Since crypto is treated as property for federal tax purposes, exchanging crypto for a good or service results in a disposal of the crypto, and consequently a short or long-term gain or loss would need to be calculated and reported. First-Out (FIFO) and Specific Identification are currently acceptable cost basis methods. Learn more about this here.
- SWAP Crypto for Another. The taxpayer does not have to cash out to U.S. dollars to trigger a taxable event. Swapping one cryptocurrency for another is treated the same way as if you sold for U.S. dollars and purchased the new crypto with U.S. dollars. Learn more about this here.
- HARD FORK of a Blockchain. Revenue Ruling 2019-24 states that if you received new units of cryptocurrency as a result of a hard fork, you will need to recognize ordinary gross income based on the fair value of the new coin or token at the time of receipt. There are of course further complications such as whether your wallet supported the new chain or whether you needed to do something to claim the forked coin before you exercised “dominion and control” and had “accession to wealth”.Learn more about hard forks and the related tax implications here.
- AIRDROP of Crypto. The Revenue Ruling states that if you received new units of cryptocurrency as a result of an airdrop, the taxpayer would recognize ordinary gross income based on the fair value of the new coin or token at the time of receipt. The reality is that the majority of these airdropped tokens as part of a marketing campaign hardly exceeds a value greater than zero. Learn more about Airdrops and why Revenue Ruling 2019-24 created so much confusion in the crypto community.
- MINING Crypto. Mining income will be treated as taxable ordinary income. According to IRS Notice 2014-21, when the taxpayer successfully mines virtual currency (bitcoin is classified as convertible virtual currency), the fair market value of the virtual currency as of the date of receipt is includible in gross income. If a taxpayer's mining of virtual currency constitutes a trade or business and not undertaken as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax. You can also deduct your business expenses incurred to produce mining income. Learn more about crypto mining here.
- STAKING Crypto. “Staking rewards” is currently an area of hot debate. On July 29, 2020, Congress sent a letter to the IRS stating that it’s “important that tax policy does not indirectly dissuade U.S. taxpayers from participating in this promising new technology”. The letter went on to say taxing “staking” rewards as income may overstate taxpayers’ actual gains and result in a “reporting and compliance nightmare for taxpayers and the Service alike.” As with most regulatory compliance matters, it's usually advisable to err on the side of caution and take a conservative approach. In the case of staking rewards, it would most likely be to recognize income at fair value until further guidance is provided by the IRS. Learn more about staking and decentralized finance (DeFi) here.
- GIFTING Crypto. According to the IRS FAQ, “If you receive virtual currency as a bona fide gift, you will not recognize income until you sell, exchange, or otherwise dispose of that virtual currency.” Generally, for the donor of the crypto, the gift will be non-taxable if it's less than the annual exclusion for gift tax. Learn more about your related deduction and other key considerations when a taxpayer receives or donates crypto as a gift.
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Disclaimer: This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.
