American Taxpayers: Virtual Currency and Taxation

It’s no secret that with COVID-19 plunging out stock market into a state of volatility many personal investors have taken the Bullish approach of buying when the prices are low. Leaving all opinion aside on some of the happenings, such as GameStop, we should turn our attention to what is happening with Virtual Currency and ask what does this mean for taxpayers. This is an area of tax that has been the topic of conversation around the Globe with tax authorities, Government and regulating bodies.

What is Virtual Currency and how is it taxed?

IRS Guidance and Information

You may have noticed on your 2019 return that you were asked teh specific question:

“At any time [during 2019] did you receive, sell, send, exchange, or otherwise acquire any financial interest in virtual currency?”.

This was part of a new focus of the IRS to track taxpayer’s ownership of virtual currency. For 2020, this question is front and centre on the first page of the 1040 rather than the Schedule 1, which not all taxpayers were required to file for 2019. This question is mandatory and must be answered truthfully. However thought that needs to be put into this as the IRS instructions define Virtual Currency as:

…a digital representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, or a medium of exchange.”

The term virtual currency is used to cover many forms of digital currency which can be converted to Fiat Currency and includes cryptocurrency and other digital assets.Basically the IRS guidance states that is it appears to be virtual currency, then regardless of the label, it will be treated as virtual currency.

What Is a reportable Transaction?

If you engaged in any transaction involving a virtual currency then you are required to tick YES to the question on page 1 of Form 1040 relating to Virtual Currency.

Further guidance is available in the IRS instructions but we have made some points below on when yo will need to tick YES:

  • You received or transferred virtual currency for free (including from an airdrop or hard fork).
  • You were paid or paid someone else in virtual currency for goods or services.
  • You sold virtual currency for an amount of consideration.
  • Virtual currency was exchanged for other property such as another virtual currency.
  • You disposed of a financial interest in Virtual currency.

If you only hold virtual currency in a Wallet or an account and you make a transfer to another wallet or account you own, then this is not considered a reportable transaction. However, we are seeing an increase in attention from the Financial Crimes Network on whether holding virtual currency in an account should be reportable, especially where Americans are subject to the FBAR and FATCA rules. More on this to follow.

Many believe that virtual currency is not taxable until exchanged for real//fiat currency and that is simply not the case. Each situation must be looked at individually and a determination based on the IRS guidance and the facts and circumstances. The IRS, and many other taxing authorities, determine that holding virtual currency for investment purposes and later disposing of this, are subject to the Capital Gains tax regime. In this case the virtual currency is treated, and taxed as the disposition of a capital asset reportable on your Schedule D. Like wise if you received virtual currency for goods or services sold then this will be reportable as compensation and taxed as such.

For example a self-employed person may be paid in virtual currency as part of completing a contract or selling an item. This will be reportable as gross receipts on their Schedule C.

It’s important to keep in mind how complex the rules are for Virtual currencies especially when this asset is held in various accounts and exchanges are taking place. It is always advisable to speak to an adviser who is knowledgeable in this arena. A good starting place for any US taxpayer who has an interest in virtual currency would be the IRS FAQ page.

Are Virtual Currency Account Reportable on the FBAR or Form 8938?

The current rules and guidance on the reporting of virtual currency and digital assets are not as clear cut as we would like them to be. As of this date Virtual Currency is not reportable on the Foreign Bank and Financial Account Reporting forms (FinCen 114, or FBAR). However that may all change as the FinCEN have stated they take the view that virtual currency as like any other fiat currency for reporting purposes.

As virtual currency continues to be used in a many illegal operations and money laundering activities the Financial Crimes Enforcement Network (FinCEN) are taking a closer look at how they can close this gap and prevent illegal activity through the transactions of virtual currencies. To date the FinCEN are taking comments on the proposed regulation and we await the word on what this means for taxpayers. With regards to FATCA, the IRS takes a different view to FinCEN and as mentioned earlier, they do not see the virtual currency as currency, but rather as property.

This would lead us to believe that the FATCA rules do apply but again, the instructions to Form 8938 do not address this. For those living overseas, who hold digital assets or virtual currency in a financial account (deposit or custodial) located outside the USA, and exceed the filing thresholds, it may be safest to over report rather than under report.

Form 8938 – Statement of Specified Foreign Financial Assets does not impose a tax on assets held outside the USA in financial accounts and so taxpayers may want to take the conservative approach of reporting their virtual assets held in non-US accounts.

As always seek advice from an tax practitioner who is experienced in the international aspects of US taxation and has dealt with FATCA and FiniCEN reporting.

End Note

As always tax is a moving target for professionals each year and we aim to keep you updated with the latest and greatest from the changing tax laws.

Virtual currency is specifically identified as one of the IRS Active Campaigns of addressing non-compliance in the US tax system both for taxpayers living inside and outside the USA.

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