By Jonathan Cohen-Gorczyca, CPA, MSA and Tyler Pickunka
Cryptocurrency has become ever more popular over the past few years, so much so that there are athletes being paid in it, sports arenas are changing names to cryptocurrency exchanges and platforms, and even commercials are being aired during the big football game; it has transcended into everyday culture.
Now, cryptocurrency is more accessible than ever, and with so many new phone and computer applications, anyone can buy and sell the digital currency at any time. As it has become more popular, government and regulatory agencies have taken notice and are dedicating more time and funds to changing laws, issuing notices for non-reporting and tax avoidance, and closing the gap in treating it like any other tradable security.
What follows are some basic, but frequently asked, questions to assist you with your cryptocurrency, tax filings, and common treatment for taxation.
How do I obtain cryptocurrency?
Cryptocurrency can be purchased on numerous online platforms whether on your computer or phone. Some of these platforms are strictly cryptocurrency only, while others also allow the trading of publicly traded securities. Certain traditional investment companies have created funds to allow you to purchase, hold, and sell shares of cryptocurrency with your regular investments. This can remove some of the perceived risk of buying and selling on the online platforms.
How is cryptocurrency taxed?
Cryptocurrency is taxable when a taxpayer sells virtual currency for U.S. dollars, exchanges one type of virtual currency for another, receives virtual currency for services, and mines virtual currency. While trading, exchanging, receiving, or giving virtual currency for services are considered capital gains or losses for tax purposes, mining virtual currency is considered ordinary income.
Mining virtual currency is the actual process where new cryptocurrency is created and enters into markets.
Can I gift cryptocurrency?
Yes, but cryptocurrency is not exempt from gift-tax filing requirements if you want to transfer holdings to someone else. The fair market value at the time of the gift, and not the basis, is the value used for gift tax purposes. Your existing basis of the Cryptocurrency transfers to the giftee; this treatment is like stocks. The holding period is transferred as well when determining short- or long-term capital gains if the giftee is to sell or transfer the gift.
When do you check the box on the tax return?
In recent years, the Internal Revenue Service (IRS) has added a question to page 1 of the Form 1040 regarding cryptocurrency to better regulate the taxation of cryptocurrency and hold taxpayers accountable for reporting their taxable transactions. The box on the tax return should be checked for all taxpayers who received, sold, exchanged, or disposed of any financial interest in any virtual currency. If you buy and are holding onto virtual currency and have not done any of the above, you do not need to check this box. If you select “No” and are involved in the active buying and selling of cryptocurrency, this could be considered perjury on an official government form.
Do you have recommendations that make tax reporting easier?
Dissimilar to publicly traded securities, most cryptocurrency platforms do not issue a Consolidated 1099 statement tracking gains or losses. A taxpayer will most likely receive a 1099 MISC or 1099-K. These two tax forms do not provide enough information to make determinations such as if the cryptocurrency was held short-term or long-term, but rather just an aggregate of all activity. One option is to find an online platform that provides this report at year-end.
Another option is to use a third-party software where you can consolidate your trading activities and can generate a report at year-end to hand to your accountant. If you are just provided with multiple ledgers, it is very difficult (almost impossible) to decipher your activity throughout the year.
Understanding the tax implications for cryptocurrency is a must if you have or plan to have it. Contact your accountant for additional information about cryptocurrency and what that may mean for your specific tax situation.
Jonathan Cohen-Gorczyca, CPA, tax manager, has been with Melanson for 10 years andspecializes in individual and business tax returns, compilations, and review engagements; Tyler Pickunka is a recent graduate from Westfield State University who has been a part of the Melanson tax team since 2020.