Bitcoin has been all over the news recently. Although we hear a lot about it, we are left with numerous questions. What is it, how does it work, and how we deal with it from a tax reporting perspective? Now, other cryptocurrencies are hitting the mainstream. All of this makes us wonder, will these cryptocurrencies continue to shape our future or is all of this a fad that will die down within a year? Jamie Dimon, chairman and CEO of JPMorgan Chase stated in October that “If you’re stupid enough to buy bitcoin, you’ll pay the price one day.” More recently, on December 12th, he stated: “Look, everyone has a personal opinion about Bitcoin. I remain highly skeptical of it. But as I’ve said previously, I’m open-minded to uses of cryptocurrencies if properly controlled and regulated.”
What are Cryptocurrencies?
A cryptocurrency is a digital or virtual currency that uses cryptography for security and is not issued by any central authority. For this reason, it is difficult for governments to manipulate or provide any kind of control or oversight. Bitcoin is by far the most popular cryptocurrency, but there are many other cryptocurrencies that are beginning to gain traction. These include Ethereum, Ethereum Classic, Litecoin, Ripple, and Dash.
How about Bitcoin?
Bitcoin was the first cryptocurrency. It was released in 2009 as an open-source software. It, along with other cryptocurrencies, leverage the use of blockchain, which is a digital ledger in which transactions me in bitcoin or another cryptocurrency are recorded chronologically and publicly.
The market price of a bitcoin remained substantially low until 2013, where it shot up to over $1,000. Since then, market price fluctuated in the $200-$800 until this year, where it hit $10,000 as of a couple of weeks ago, and is trading at $16,000 as of the date of this article. The Winklevoss twins, who many may know from their famous lawsuit against Mark Zuckerburg, recently became the first “Bitcoin Billionaires.”
Tax Reporting for Bitcoin
The IRS has released some guidance for the tax implications of Bitcoin and other cryptocurrencies (virtual currencies) with the release of Notice 2014-21. Within this notice, they state that virtual currencies are treated as property for federal tax purposes. Fair market value must be determined in U.S. dollars and capital gains rules apply if the taxpayer sells or exchanges virtual currency.
However, there has been some debate about the applicability of like-kind exchanges. The IRS has remained silent about 1031 (like-kind) exchanges for virtual currencies. One idea is that Bitcoin for Bitcoin exchanges might qualify, but a Bitcoin for Ethereum trade might not qualify. However, this question might be irrelevant if a new tax bill passes that limits like-kind exchanges to real-estate property.
The payment of virtual currency can also constitute wages if paid to an employee. If an independent contractor receives more than $600 of virtual currency, Form 1099-MISC will be required.
How about Bitcoin Mining?
The use of computer resources to validate transactions and maintain the public Bitcoin transaction ledger (mining), is classified as income at the fair market value of the virtual currency as of the date of receipt. Mining constitutes a trade or business. This can constitute self-employment income if the activity is not undertaken by the taxpayer as an employee.
Stay tuned for updates on this subject and if you have any questions, set up your no-cost consultation or give us a call 704-841-1120.