How to Pay Taxes on Cryptocurrency Transactions While Complying with IRS Requirements?

Cryptocurrency or virtual currency is now a significant player in the financial market. As a result, several challenging legal and regulatory questions have been raised globally.

While cryptocurrency and its utilized technologies could transform business processes, its inherent decentralized nature could serve as a vehicle for malicious activity and a challenge to those who need to stay compliant. 

The Internal Revenue Service (IRS) issued preliminary guidance on applying general tax principles to virtual currencies that have an equivalent value in real currency or acts as a substitute for one.

The IRS does not view cryptocurrency as generating foreign currency gain or loss for U.S. federal tax purposes; rather, it treats the currency as property. 

Because of this, cryptocurrency can now be characterized as an investment asset like stocks, business property like inventory, or personal property. Considering that a taxpayer cannot deduct personal losses, the IRS must further distinguish between holding a virtual currency for investment and their own purposes. 

Accepting property (incl. cryptocurrency) for goods or services

For a taxpayer who receives cryptocurrency as payment for goods and services, the transaction must include its fair market value (FMV) at the time of receipt in gross income.

FMV may be determined from the current exchange rate established by the market as determined by supply and demand. For independent contractors, receiving cryptocurrency for performing services are also subject to self-employment tax. 

FMV is deemed the owner’s “basis” in the property, thus any value increase indicates a taxable gain. Vice versa, if the cryptocurrency merchant exchanged the accepted asset lately for a lower price than at the moment of receipt, he has a loss which is also taxable.

Example. John is a clothing merchant who accepts Ethereum in his store. Yesterday, when the price of ETH was $200, John sold a pair of jeans for 1 ETH. He decided not to hurry with exchanging his ETH to fiat, but suddenly found himself selling 1 ETH for $180 a few days later. So, John should report a $20 loss. That’s how the volatility of crypto may affect you.

Converting Bitcoin to fiat currency immediately helps you avoid the risk of a future loss.

Since it is so difficult to record, exchange and report on each cryptocurrency payment, the overwhelming majority of crypto-friendly merchants, who accept crypto payments each month, exchange bitcoins or other cryptocurrencies to fiat immediately upon acceptance before the FMV of the crypto asset changes. Using third-party services, an entrepreneur can simplify the process of receiving crypto, but still needs to account for the history of transactions.

Most popular Bitcoin payment processing services are:

• BitPay, charges 1% fee;
• CoinGate, charges 1% fee;
• Coinpayments, charges 0.50% fee.

Record and evaluate your transactions

For those businesses and merchants who engage in a larger volume cryptocurrency microtransactions, the recordkeeping required for tax purposes can be overly demanding and challenging. To solve this problem, the accounting of crypto transactions can also be automated at any scale for individuals and businesses alike. Taxpayers can be at ease in tracking all of their virtual currency transactions.

Blockchain monitoring services deliver you all the transactions happening on the blockchain and simultaneously compile the raw transaction data in a way suited to your exact needs. For example, you can add the market price data to reflect the fiat value of a crypto transaction and automatically record it in a Google Spreadsheet. As such, you can define how you want the financial data from your crypto transactions to be amassed and transformed. 

You also have the option to deliver the data to any outside applications. For example, PARSIQ automates the transfer of data retrieved from the blockchain to aggregate it, and then transform the data into useful analytics for your chosen delivery channels or integrations. These results can be delivered in a combined form to apps such as Google Sheets or common accounting software you already use. On top of that, you can choose to receive timely instant notifications straight to your messaging app such as Telegram. 

The most flexible option for recording is to work with common formats such as .csv or .pdf for ease-of-use. In this format, you use it for financial reporting to work with the data in other environments. Thus, all your transactions can be transformed into a combined format common to existing accounting standards. 

Businesses accepting cryptocurrency should account for it based on its cash equivalent.

Be sure to keep track of all taxation information, including the date, amount, and fiat value for cryptocurrencies transactions. The more info you have, the better you can report taxes and minimize how much tax to pay. Again, you can use third-party blockchain monitoring services to somehow simplify the process of tracking, recording, and measuring all of these transactions.

File your papers

First of all, it’s highly recommended to read the official IRS guidance on cryptocurrency. Reporting on crypto income depends on many factors such as holding period or method of acquiring. Let’s see the basics applicable for merchants, who accept crypto as payment for goods or services.

#1. Tax rate.
Your tax rate depends on taxable income. The federal tax on crypto income may range from 10% to 37%. See the example table here. Please note that there may be state income taxes to be paid.

#2. Holding period.
Lucky crypto merchants are, as the holding period for such income doesn’t matter in their case.

#3. Crypto capital losses.
Cryptocurrency losses can be used to offset capital gains or to be deducted from other kinds of income, up to $3,000. 

#4. Reporting.
Reportable capital gains and losses are typically recorded on Schedule D of Form 1040.

Conclusion

The global interest in the cryptocurrency application is growing every day. Earlier, I mentioned the case when a simple notification "we accept bitcoin" on a merchant's website can blow up his or her sales. Crypto-friendly entrepreneurs want to be able to accept cryptocurrencies as a form of payment in order to expand their target audience and become more flexible. 

Managing the legal and tax consequences associated with virtual currencies is a responsible task that should always be carried out under the supervision of a tax adviser. This article was made for a general acknowledgment and doesn’t contain any financial advice.

At the same time, with the help of blockchain monitoring platforms and merchant service providers, one can simplify operational issues and reduce the legal risks of accepting cryptocurrency payments.

Warning: this article was made for a general acknowledgment and doesn’t contain any financial advice.