If you have interacted with bitcoin or other forms of cryptocurrencies during 2020, you should be prepared to report the information to the IRS on your 2020 tax return. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency (i.e., coin or paper money), but it does not have legal tender status in any jurisdiction. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.
Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency that can be traded between users and purchased for, or exchanged into, real or other virtual currencies.
A new yes or no question is located on the 2020 Form 1040 just below the taxpayers’ name. “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” No matter how you may have come into possession of said virtual currency, you are expected to let the IRS know about it. In 2019, the IRS sent letters to more than 10,000 taxpayers with cryptocurrency transactions who may have failed to report income and pay taxes owed. It is important to remember that a “yes” to this question does not necessarily mean paying additional tax, but it is alerting the IRS as to your involvement with virtual currency in some level. Giving the virtual currency such a prominent place on the 1040 could be an indication that the IRS will begin tracking this more going forward.
If you received any virtual currency as pay for work performed, the income is subject to ordinary income taxes, as well as self-employment taxes if paid as nonemployee compensation. Even if you did not receive a 1099-NEC or other form reporting the pay, it is still your responsibility to report the income and pay the taxes owed. Alternatively, if you did not get paid cryptocurrency for work performed, the IRS generally views bitcoin and other forms of virtual currency as property, subject to capital gain treatment. In this scenario, the taxable transaction can occur when you convert the cryptocurrency to currency and when you sell or exchange it in the future.
As the IRS gets more serious about cryptocurrency transactions, a shift will be made toward compliance and enforcement. Failing to report income can carry hefty penalties, interest and even prison time. Keeping careful records of your transactions is critical to helping with tax reporting requirements especially as the world of virtual currency continues to evolve and become more prevalent in our everyday lives.
If you need assistance or have any questions related to bitcoin or other virtual currencies, and the related reporting requirements, please call your CironeFriedberg professional. You can reach us by phone at 203-798-2721 (Bethel), 203-366-5876 (Shelton), or 203-359-1100 (Stamford), or email us at firstname.lastname@example.org.