Making Sense of the IRS Guidance on Cryptocurrencies [Updated 2020]

IRS has provided updated guidance. Here is our comprehensive analysis of the guidance, steps by the IRS in educating users about cryptocurrency, laws around it and forms necessary to file cryptocurrency taxes.

Read through various sections to understand the summary of guidelines, treatment of virtual currency by the IRS, tax implications, pitfalls to avoid and various other scenarios.

What does it have for traders?

The updated guidance from IRS suggests that it is staffed with knowledgeable persons who understand the jargon better when it comes to the ledgers, on-chain vs off-chain transactions, airdrops, etc., This is a good sign as the upcoming regulations will be very informed in nature and would help increase the adoption among the masses. 

A TL;DR summary

Some of the key points that were confirmed in today’s FAQs provided with IRS guidance on cryptocurrency.

• Specific identification while defining gain/loss is allowed – else, FIFO should be the way to go.
• More emphasis on fair market value (FMV) based on the timestamp of the transactions.
• “Crypto to Crypto” or “Exchanging Crypto for goods/services” is a taxable event.
• Cost basis includes fees, commissions and other acquisition costs in U.S. dollars.
• Paid in crypto is considered income and should be reported as income by FMV of crypto on that date.
• Paying for services or goods using crypto results in a capital gain or loss.
• No income needs to be reported in case you don’t receive a new coin after a hard fork.
• The value of a new coin (if received) will be the FMV at the time of the issue. If the coin you own has no published value, then value = value of goods/services exchanged
• No tax implications when a soft fork happens.

GIFTS RELATED INFORMATION

• To calculate gain, the purchase price of a gifted coin is donors basis+gift tax
• If it’s a loss, the purchase price will be lesser of the donor’s basis or the fair market value.

IRS definition of Virtual Currency

The IRS has been working well on defining various cryptocurrency-related terminology and also help citizens understand the tax liabilities and activities that lead to taxable events.

According to the IRS, “Virtual Currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value.”

Following is the screenshot from the original definition of Virtual currency by the IRS. However, a recent modification or edits to the document suggest having removed the Robux by Roblox (virtual currency in the Roblox game to buy avatars and create custom upgrades) and V-bucks of Fortnite game (virtual currency inside the Fortnite game to buy weapon upgrades and more virtual abilities inside the game).

This suggests that the IRS has been working constantly on understanding various virtual currencies and how they are different in operational structure.

What constitutes a store of value and also a means of transfer, would lead to taxable events. The department has been busy the past year in upgrading its guidance and jargon.

Bitcoin is one example of a convertible virtual currency

As you see the difference between above screenshot and the below screenshot of the definition of Virtual currency on the IRS website, it clearly states that Bitcoin remains to be the only example and thus makes their stance and focus on cryptocurrencies in specific and not other gaming currencies.

Legal framework with the introduction of “virtual currency question” on Form 1040 Schedule 1

The IRS has recently published a draft and then the final version, now available and necessary for taxpayers to select appropriate action on the Schedule 1 of Form 1040 while declaring ‘Additional Income and Adjustments to Income’ on their taxes.

The aim of this question is to remove the situation where the taxpayer could claim to be ignorant of the tax laws around cryptocurrency. When one selects the box “No” on this form, you are wilfully mentioning that you didn’t involve in virtual currency transactions.

If the IRS figures out that you are involved in trading or holding a cryptocurrency, they can come back at you with huge penalties.

Updates on Technology & Jargon

It is no longer about a blanket term of cryptocurrency or virtual currency and buying/selling to USD is not the only way a taxable event could occur.

The IRS website talks about airdrops, hard forks, soft forks, on-chain, off-chain, gifts and many more possibilities of acquiring cryptocurrency. Elaborating the underlying technology like blockchain and Directed Acyclic Graphs (DAG – an example is IOTA cryptocurrency) and how certain transactions could be taxable and certain are not.

However, most of the acquisition ways constitute income in cryptocurrency and needs to be reported on your Income taxes.

It is important to figure out your transfers within your own accounts on various exchanges and wallets to avoid unnecessary taxable events. Also, at the same time, it is important to classify all kinds of income received in cryptocurrency and report it appropriately along with capital gains or losses.

IRS is the biggest consumer of Chainalysis

When it comes to finding the tax evaders and bad actors, the IRS has all the tools necessary to find out such actors. Recent reports on Blockchain analysis and forensic tool Chainalysis show that the IRS is their biggest customer and been spending millions of dollars in finding tax evaders and bad actors using virtual currency or cryptocurrency to carry out illicit activities.

Keep in mind that blockchain is very transparent and traceable when some bad thoughts come to your mind, even if it is a small taxable amount. Everything can be traced back to you via the exchange accounts or the emails that provide confirmation of deposit, transfer, sell or buy of cryptocurrency.

Always pay your taxes, be compliant and be on the right side of the line.

Warning Actions for Not Reporting Crypto

Exchanges operating in the US are mandated to provide the information of individuals trading more than $10,000 USD or 200 transactions in a tax year via a Form 1099-K. According to the IRS, A Form 1099-K includes the gross amount of all reportable payment transactions. More information on this available here

These forms are sent to the IRS too and this information is used to identify taxpayers who are skipping crypto on their taxes. The IRS has already sent blanket letters to many such cryptocurrency traders and also sent notices for misreporting or under-reporting their crypto trading activity.

Income reporting requirements

As mentioned above, there are a various ways one could acquire cryptocurrency starting from getting paid in cryptocurrency to a free airdrop from a particular platform to improve the network effects. In any such cases, the onus is on you to classify such earnings in cryptocurrency, denominate in USD and declare as income on your taxes.

BearTax interface to report income, transactions, and Documents needed by IRS

As per IRS answers, you must report ordinary income from virtual currency on Form 1040, U.S. Individual Tax Return, Form 1040-SS, Form 1040-NR, or Form 1040, Schedule 1, Additional Income and Adjustments to Income (PDF), as applicable.

Autogenerate the necessary documents

Everything said above could be overwhelming and if you are looking to breeze past your taxes, you are at the right place.

BearTax is a platform that is built to comply with all the guidelines provided and calculates your tax liability in minutes. This will help you consolidate your trades from all exchanges, wallets to report capital gains/losses, income on your taxes with great confidence.

You can generate all the necessary cryptocurrency tax documents without any additional effort.

Yes! You can with BearTax.

If you have traded cryptocurrency and would like to comply with the guidelines, import all your transactions to BearTax and generate your tax documents within minutes. Let the bear take care of all the cost-basis, proceeds and other hard calculations.

BearTax interface for downloading tax forms

Export the documents to PDF or TurboTax and file your taxes.

Signup now using this link and get started.

(Disclaimer: The author is the Founder and CEO at BearTax)