If you’re feeling inspired by John McAfee’s decision to stay at sea for the next two years to avoid the IRS, you probably shouldn’t. The IRS and cryptocurrency are no longer strangers. Just because you think your digital assets can’t be tracked doesn’t mean you don’t have to pay taxes for the money you make on the blockchain.
On the contrary, the US government aims to ensure that traders, owners, and investors pay their dues. After a federal judge in California forced Coinbase to hand over details of over 14,000 users to them, the IRS has proven that it has no intention of leaving tax evasion attempts unpunished.
So, here are five things you should know about the IRS and cryptocurrency to make sure you report your earnings correctly and avoid potential prosecution.
1) IRS and cryptocurrency: a compliance priority
The Internal Revenue Service (IRS) published the first guide on cryptocurrency taxes in 2014. It has updated its policy several times to stay up to date with the market and clarify how to report taxes on crypto income.
By now, you probably know that digital assets, tokens, and coins are treated as investment property (not as currency). This means that users should pay taxes on their profit every time they sell their crypto, trade one coin for another coin, or use cryptocurrency to make purchases.
The good news is that, at least for now, owners of virtual currency accounts don’t need to file for FBARs (Reports of Foreign Bank Financial Accounts).
However, the IRS now has a team of cryptocurrency experts collaborating to reduce tax avoidance. The authorities are taking crypto pretty seriously, and more rules and regulations are sure to emerge in the coming years.
2) J5 to combat non-compliance
The Joint Chiefs of Global Tax Enforcement (J5) is an alliance of tax enforcement agencies from the UK, the US, Canada, Australia, and the Netherlands. Its goal is “combatting transnational tax crime”. And this collaboration may have effects on the cryptocurrency market as well.
Not only will it fight against tax crime and money laundering, but it will also collaborate internationally to counter the “growing threat to tax administrations posed by cryptocurrencies and cybercrime”.
More and more governments are working on cryptocurrency regulations regarding data storage and legal ways of gaining access to the transaction history of cryptocurrency exchanges. So, be sure to know the rules wherever you live.
3) Forms for reporting cryptocurrency
Despite the high number of questions still surrounding the IRS and cryptocurrency, one thing is for sure: as long as there’s a form you can file for reporting cryptocurrency on taxes, there’s no legal way you can escape your obligations.
Also, for payments using cryptocurrency for service providers or independent contractors, employers should issue form 1099.
Note that, according to the IRS rules, stock transactions use the FIFO method of accounting (first-in, first-out) as default. However, you are allowed to use other accounting methods as well, with different effects on your gain on crypto transactions.
4) Digital coins received as income
For most cryptocurrencies, you only pay taxes when selling or using them to make purchases. But things are a little different when you receive cryptocurrency as a wage.
In this particular case, you should report employee earnings using W-2 forms in dollars. That’s why it’s essential that you keep accurate records of the value of your digital coins in USD on the date of each payment you receive.
5) Crypto losses
Since cryptocurrencies are treated as investment property for federal tax purposes, you can write off your losses to pay less tax. You can also use your losses to offset gains from other trades, including stocks, and even regular income.
For net capital loss under or equal to $3,000, you can use the entire amount in one year. If your loss is higher than $3,000, the exceeding amount can be rolled forward to the next year.
Final thoughts on the IRS and cryptocurrency
There’s no doubt that the US government isn’t kidding around. The IRS and cryptocurrency may not have a long history, but things are going to change. More traders and investors will have to respect the law, and anonymity on the blockchain won’t always work as a shield for tax evaders.
For now though, most exchanges aren’t compelled to send tax forms to you or the IRS. According to the rules, you’re the only person responsible for reporting your income and transactions – and for paying taxes on them.
This will likely change moving forwards. So, if you’ve been flying under the radar, it’s probably a good idea to start keeping logs of your transactions from now on to avoid getting on the wrong side of the IRS.