Operation Hidden Treasure: Cryptocurrency and taxes
January 10, 2022
by Kamren Scott
Cryptocurrency has taken the world by storm, but what is and how is it taxed? Find out what you need to know about virtual currency and how it’s reported and taxed in today’s article.
Virtual currency background
Cryptocurrency is a type of virtual currency, but often the terms are used interchangeably.
Here is how the IRS defines virtual currency:
“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., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance), but it does not have legal tender status in the U.S. 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.”
While there were some digital currencies in the 1990s, the birth of cryptocurrency is generally viewed as when bitcoin was launched in 2009.
The historical attraction of cryptocurrency by many enthusiasts is that it isn’t government-controlled and the ability to use it anonymously. And for some to avoid income taxes.
How virtual currency is taxed
Despite some misconceptions, virtual currencies are subject to federal income taxes. Virtual currencies are typically treated as assets by the IRS.
Here are some basic ways virtual currencies like bitcoin are taxed:
- If you buy some virtual currency and later sell it for a gain (if the dollar value went up), it is taxed like an asset, either as a short-term gain or a long-term gain. A short-term gain is taxed higher than a long-term gain usually – at your marginal tax rate. A long-term gain (an asset held for one year and a day or longer) is taxed at a lower rate, which depends on your total income.
- If you create the virtual currency (like in bitcoin mining), you are taxed like it is earned income. Although in many cases, the process can be treated as a business, so valid business expenses may be deducted.
- If you earn interest off of the virtual currency, that is considered income just like other interest and taxed at your marginal tax rate.
Virtual currency taxation is complicated, but these three basic concepts are a good starting point.
Here is an example that some people might not consider:
If you buy some virtual currency for $20 and later use that same virtual currency to buy $40 of pizza, you have had a $20 gain. The U.S. government and the IRS view that $20 gain as taxable income.
What is Operation Hidden Treasure?
Operation Hidden Treasure is the IRS campaign to find individuals who are not reporting virtual currency income.
Each year the U.S. government is increasing efforts to ensure tax compliance among taxpayers who use and invest in virtual currencies.
Right now, the reporting requirements for institutions that handle virtual currency and who broker virtual currency transactions are minimal. Taxpayers should know that just because they don’t get a tax document due to their virtual currency transactions doesn’t mean income from virtual currency isn’t taxable. It is very much taxable.
You can find more information on the taxation of virtual currencies at irs.gov here.
New reporting requirements
On Nov. 15, 2021, legislation was signed into law that increased the reporting requirements for virtual currencies.
Brokers of transactions involving digital assets will be required to report transactions to the IRS on Form 1099B or similar forms.
This means you will receive tax documents about your virtual currency transactions to be used when preparing your tax return. And it means the IRS will be expecting to see those transactions on your tax return. This reporting requirement starts on Jan. 1, 2023, which provides time for the IRS and other entities to work out the details of the new changes.
But don’t wait to make sure your virtual currency and cryptocurrency ducks are all in a row.
You should be tracking when you get virtual currency, how much you pay for it,g when you sell it, and how much money you receive for the virtual currency. And yes, if you earn money on virtual currency, it should be factored into your tax return just like the other ways you earn money.