With exponential gains in value and thousands of new retailers now accepting it as payment, Bitcoin has suddenly become one of the hottest discussion topics around the country. Bitcoin (BTC) is currently the most circulated virtual currency (also referred to as cryptocurrency, or “crypto”) in the world and can be exchanged for U.S. dollars, Euros, and other real or virtual currencies like Ethereum (ETH) and Ripple (XRP).
You may spend virtual currency to pay for products or services, or you may treat it like an investment or commodity and hold onto it. But how is a virtual currency like Bitcoin taxed and treated by the IRS? Do you have to pay taxes on Bitcoin? Depends on what you do with it.
- How is virtual currency like Bitcoin handled for federal tax purposes?
Virtual currency held as a capital asset, like stocks or bonds, is treated as property by the IRS. A gain or loss from the sale or exchange of Bitcoins that were held for more than one year is taxed as a capital gain (15% tax rate for most taxpayers) or loss. For the sale or exchange of cryptocurrency that is not a capital asset by the taxpayer, it’s considered as an ordinary gain or loss.
For example, let’s say you purchase one Bitcoin as an investment on January 11, 2018, for $13,557. More than a year later on March 25, 2019, you sell it for $15,787. Your long-term capital gain would be the positive difference between what you paid and what you sold it for, or $2,230, which would be taxed at 15% (for most taxpayers), or $334.50, that you would owe in capital gains tax to the IRS for tax year 2019.
- If a taxpayer receives BTC as payment for products or services, how should they determine gross income?
Gross income must be calculated using fair market value in U.S. dollars as of the date the cryptocurrency was received. Fair market value of the crypto is determined by converting it into U.S. dollars at the rate listed on an exchange governed by supply and demand. Some popular crypto sites and exchanges for valuating BTC, ETH, and XRP include CoinMarketCap, CoinGecko, Gdax, and Binance.
Sample cryptocurrency exchange showing prices of BTC, ETH, and XRP on Jan. 11, 2018. Image courtesy of CoinMarketCap.
- Is virtual currency paid to an independent contractor for work performed considered self-employment income?
Yes, all gross income paid to an individual, including crypto, for work performed not as an employee is considered self-employment income and is subject to the self-employment tax.
For example, as compensation for freelance graphic design work you did for a local business, on January 11 you’re paid one Bitcoin, which is valued that day according to an exchange at $13,557. A week later on January 18, you need cash to pay rent and some bills, so you sell the Bitcoin for $14,117. Even though you sold the Bitcoin for more than it was worth when you got it, you’re taxed on the value of the crypto the day you received it, which is $13,557. Since the federal self-employment tax rate is 15.3%, the amount owed in taxes would be 15.3% of $13,557, or $2,074.22.
- Does cryptocurrency paid by an employer for services count as wages for employment tax purposes?
Yes. The type of currency used to pay for an employee’s services doesn’t affect whether the compensation counts as wages for employment tax purposes. The fair market value of virtual currency paid as wages is subject to federal income tax withholding and must be reported on the employee’s W-2.
- If a company pays an independent contractor with Bitcoins, must the payer file an information return with the IRS?
If an independent contractor is paid $600 or more in Bitcoins (according to fair market value) in a taxable year by a business, the payer is required to report it to the IRS and the payee with IRS Form 1099-MISC.
- If you “mine” cryptocurrency, do you have to count it as gross income?
If a taxpayer “mines” crypto by using computing power to validate BTC transactions and maintain the public BTC transaction ledger, the fair market value of the mined virtual currency on the date it’s received is considered taxable gross income.
- If someone mines Bitcoins as their personal business, is the income subject to self-employment tax?
If an individual mines BTCs, and the mining isn’t as an employee, the net earnings are considered as self-employment income and are subject to the self-employment tax.
So, do you have to pay taxes on Bitcoin and other forms of cryptocurrency? The answer is yes, in most cases. If you own or receive Bitcoin as payment, a free tax organizer is a convenient way to keep track of your virtual currency-related tax information so you’re prepared at tax time.
Value of Bitcoin (BTC) in U.S. Dollars over the past year. Image courtesy of CoinMarketCap.
With all the speculation and volatile values of virtual currencies like Bitcoin, no one really knows what will happen in the future to these new forms of money. But if you own or receive Bitcoins as payment, you need to know how your taxes will be affected so you don’t end up paying penalties and interest to the government for failure to follow tax laws. Because even though more than 100,000 retailers now accept Bitcoins, the IRS does not.
Have questions? Contact Robert Hartman.
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