The IRS has sent their first wave of over 10,000 ‘educational’ letters to bitcoin cryptocurrency holders, warning them of serious consequences of withholding tax money. They’ve made it pretty clear that virtual currency is no different than normal assets. In fact, it is the equivalent of physical assets. 

If you need Bitcoin Cryptocurrency IRS tax help or have received IRS letter 6174 or IRS letter 6173, we are here to provide professional IRS tax help.  Call us at 407-502-2400, or email us at [email protected] and we will resolve any cryptocurrency taxes you may have.     

In 2017, the IRS ordered renowned bitcoin cryptocurrency exchange, Coinbase, to give them access to information of the more than 14,000 customers who dealt in more than $20,000 worth of BTC between 2013 and 2015.  

Coinbase is now issuing 1099-Ks to its traders, with copies going to the IRS. Traders who fail to report their transactions should expect a letter from the IRS with all the traditional penalties of underreporting income.

IRS Commissioner Chuck Rettig warned in a press release, “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties.”

While the IRS is sending bitcoin cryptocurrency holders into a frenzied rush, there’s no need to do so. This article has you covered. 

Coinbase Wants to be the First Regulated Cryptocurrency Exchange 

Coinbase added a tax reporting tool to their dashboard, known as the first in first out (FIFO) method. It displays to users their capital gains and losses. Brokers and barter exchanges usually do this by releasing a 1099-B form to their clients for whom they sold commodities, future contracts, stocks, options, debt instruments, etc.

Coinbase is using Form 1099-K, since they are a third-party network that changes bitcoin cryptocurrency to fiat and vice versa. The form reports gross value of certain transactions for clients in a year. The Form does not report your actual tax payment to the IRS. You will need an accountant for more detailed analysis and IRS tax help.

FIFO means that the first coin you buy (chronologically) is the first coin to be counted for a sale. Other methods are HIGO (highest in first out) and LIFO (last in first out). 

To demonstrate the three terms, consider the following scenarios:

Let’s say you buy one bitcoin for $300 in 2015, one bitcoin for $5,000 on September 2017, and one bitcoin for $3,000 on October 2017. You proceed to sell one bitcoin in December 2017 for $14,000. Using FIFO, your capital gains would take the $14,000 profit and subtract the first cost basis for that coin ($300 from 2015). This results in a long term capital gain of $14,000 – $300 = $13,700. 

Using HIFO, the capital gain would be $14,000 – $4,000 = $10,000. 

Using LIFO, the capital gain would be $14,000 – $3,000 = $11,000

The IRS does not mention which specific method should be used in the matter of taxation. It’s guidance for FIFO and specific identifications apply to stocks and bonds. However, the safest approach would be to use FIFO, although you may gain more tax advantage with specific identification. Make sure to consult your tax professional for IRS tax help.

Understanding Capital Gains and Losses

Selling coins in exchange for fiat currency, exchanging for other coins, and using coins to purchase goods and services, all have to be reported as a capital gain or loss. Any expenses such as coin fees should be added to the basis appropriately (to offset any gain or increase loss). 

Holding a coin over a certain period of time generates taxable income, this also applies to mining income. As an example, if you sold a Bitcoin for a certain number of dollars, this should be reported as a noticeable capital gain or loss to be reported on IRS Form 8494. Coin miners who receive a coin for their work will identify business revenue on the current value of the coin against the expenses incurred when obtaining the coin.

There are Two Types of Taxes on Bitcoin Cryptocurrency

IRS’s Guidance on Virtual Currencies defines bitcoin cryptocurrency as assets, not currency, requiring holders to pay capital gains tax. There are two types of capital gains taxes: short term and long term. Long term applies to holding a coin for a year before selling or trading it. Any time period less than a year is classified as short-term. The values depend on your tax bracket and state. Long-term capital gain taxes tend to be lower. 

Most bitcoin cryptocurrency trades are short-term capital gains, which can be taxed as high as 39% depending on your income bracket. People who hold bitcoin for more than a year and then sell it, however, are only obligated to pay long-term capital gains tax, which is levied at a significantly lower rate of between 15% and 23.8%.  

Bitcoin cryptocurrency can also be reported as earnings if you’re paid in digital coin by your employer. Your income in bitcoin cryptocurrency is subject to the seven IRS tax brackets, which is 10% to 37%. This requires you to pay the same amount in income tax as you would normally.  

The Two Forms You Need to Know About

Most bitcoin cryptocurrency investors use Form 8949 – also known as the Sales and Other Dispositions of Capital Assets – to report all their transactions. Investors use this form to describe any assets they’ve traded, included the dates they bought and sold it, the cost of trading, their net loss or gain, and how much they made. The form also distinguishes between long-term and short-term capital losses and gains.

The second form for bitcoin cryptocurrency trades is Schedule D (Form 1040). It covers the total long-term and short-term losses and gains, deriving information from Form 8949. 

Bitcoin Cryptocurrency Taxes for Miners

Digital currency miners have to include two different income streams. Miners generate income the day their coin is ‘created’ and depends on its fair market value at the time. They can report the income as a hobby or as self-employment. Reporting it as hobby requires them to include the value of the coins as “other income” on line 21 of form 1040. Hobbyists are at a disadvantage when it comes to deducing expenses.

Miners can report their earnings as self-employment income on Schedule C. This allows them to fully deduct their expenses (provided they can prove them). The net profit is then subject to income tax and self-employment tax. 

The second income stream comes from the act of selling the coins to someone else in exchange for dollars or any other currency. If the coins were worth more when you sold them than they were on the date of creation, the net difference would be your capital gain or capital loss (if they were worth less when sold). Both gains and losses are subject to the long term and short term rule for taxation.

This means you will have to keep track of each coin, the date it was created, its value at the time. This also applies to the date it was sold and its value at the time.  In case you sold your coin immediately for cash, you only have to report income from creation, without having to show capital gain or loss. 

You can start subtracting any expenses if you are operating as a schedule C business, this includes expenses for computer equipment needed for mining (including any depreciation), and other expenses (such as electricity needed to power the equipment). Before any expenses can be applied to capital gains, they have to be first proved. 

This requires the use of a separate electric meter, or having the computer equipment being plugged into an electric meter to help calculate the amount of electricity used to operate the computer equipment. Depending on how high your expenses are, you might end up paying fewer taxes as a hobby than as a business. 

Differentiating between Taxable and non-Taxable Events

You only have to report your bitcoin cryptocurrency gain on events that trigger a tax liability. According to the2014-21 notice by the IRS, these taxable events include the following:

  • Trading bitcoin cryptocurrency  to fiat
  • Trading crypto to crypto
  • Earning crypto from mining
  • Using bitcoin cryptocurrency to pay for goods and services

Events that are not taxable include the following: 

  • Giving crypto as a gift unless it meets the threshold for a gift tax. 
  • Transferring bitcoin cryptocurrency between exchanges or wallets
  • Buying cryptocurrencies (unless sold or exchanged) 

What About Hundreds of Trades?

Most crypto traders have hundreds, and even thousands, of trades, which can make the whole process challenging if done manually. There are special IRS tax helpcrypto software that can simplify the process. A good example is ZenLedger, which partnered with TurboTax to provide detailed tax analysis and automatically fills your 8949 form based on crypto trades. 

Giving and Receiving Bitcoin Cryptocurrency as a Tips or Gift

If the donor’s adjustable basis was higher than the market value of the digital coil at the time the gift was made, the receiver will have to recalculate their capital gains and losses using the donor’s basis. If the result is a loss from the donor’s original basis, then the receiver should proceed using the gift date market value as the basis. If there is a capital gain, the receiver should ignore the gain and report nothing. 

To demonstrate this, let’s go over an example: 

Let’s say Steve buys one BTC for $500, two years later, he gives it to Jon when its price has halved to $250. Five days later, Smith sells the coin. There can be three possible scenarios:

1. Smith sells the bitcoin for $600. He takes on Steve’s original basis of $500, and has a long term capital gain of $100. 

2. Smith sells the bitcoin for $150. Since there is a capital loss using Steve’s basis, he can’t use that basis. Instead, he takes on the basis of the fair market value of the bitcoin at the time of the transfer, $250, leaving a long term capital loss of $100. 

3. Smith sells the bitcoin for $350. Since there is a capital loss using Steve’s basis, he can’t use the basis. He takes on the basis of the fair market value of the bitcoin at the time of the transfer i.e. $250. However, this would yield a capital gain of $100. The law says you should disregard the sales and nothing should be reported. 

You have to keep track of the following records when receiving or making a crypto-gift: the donor’s original basis, the date of transfer (acquisition date), and the fair market value of the coin on the date of transfer. 

What If You Donate Your Bitcoin Cryptocurrency

You can donate your bitcoin cryptocurrency to any IRS-recognized tax exempt charity, a 501© organization. This means that the IRS does not require you to pay any capital gains on the transaction. You can deduct the value of the donation based on the fair market value of the digital coin on the date of the transaction. 

Why You Shouldn’t Evade Crypto Taxes

Although it is tempting to try and evade crypto taxes, indeed most people still believe it’s not taxable, the IRS believes otherwise. There is a high chance you will get caught if you try evading your taxes. The last thing you want is to pay late fees and interests which accumulate. First and foremost, it is counterintuitive because all your transactions on the blockchain are stored on a public immutable ledger forever. 

In addition, most exchanges are now starting to report trading history to the IRS, the most noticeable of these is Coinbase which was taken to court to cough up all the information.  

What Happens if You Fail to Report?

Failing to report can incur hefty fines and penalties of up to $250,000 or 5 years in prison. The IRS has made it very clear that the decentralized nature of bitcoin cryptocurrency is no longer a means of escaping fiscal responsibility. 

Get an Accountant

Through platforms like Token Tax and Coinbase, you can always receive estimates about how much tax is owed to the IRS. That said; it is always a good idea to let a professional accountant clear away the muddy waters. If you don’t feel comfortable filing on your own, consult a tax professional now for IRS tax help!  

If you need Bitcoin Cryptocurrency IRS tax help or have received IRS letter 6174 or IRS letter 6173, we are here to provide professional IRS tax help.  Call us at 407-502-2400, or email us at [email protected] and we will resolve any cryptocurrency taxes you may have.   

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