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19 Aug 2019

The IRS Reminds Taxpayers That Cryptocurrency Gains Are Taxable

Only about 8 percent of Americans invest in cryptocurrencies. But you wouldn’t know that based on the amount of media coverage that is devoted to cryptocurrency—and the cadre of media outlets that focus on it exclusively.

 Perhaps sensing that all of the buzz may grow investment in cryptocurrencies, the Internal Revenue Service recently reminded United States taxpayers that cryptocurrency is still currency, which is a form of property, and thus taxable.

A Cryptocurrency Refresher

Cryptocurrency is a digital form of currency that functions as an electronic cash system. There are no central banks or trusted third parties to create new coins and verify transactions. Cryptography takes the place of these entities and is used to confirm transactions on a public ledger. Given the decentralized nature of cryptocurrency, transactions are between two people, “peer-to-peer,” without the need for third parties.

Although Bitcoin is the most well-known cryptocurrency—having been the world’s first—there are many others out there, including Litecoin and Ethereum®. But no other cryptocurrency has seen the meteoric spike in value that Bitcoin saw in 2017 when the price for a single bitcoin soared from $900 to $20,000. These days, a single bitcoin has a price in the low five figures.

Despite the sizable fluctuations in value that are possible with cryptocurrency, more traditional companies such as Facebook® have been getting into the cryptocurrency game. And likely there are plenty of other companies, including apparently Walmart®, investigating how it can take advantage of this new form of currency.

A Reminder from Your Friendly Federal Tax Collector

Way back in 2014, the IRS issued guidance to U.S. taxpayers that made clear that the federal government treats virtual currencies as taxable property under U.S. tax law. This means that a sale or exchange of the currencies’ “coins” is a taxable event. Investors in cryptocurrencies must also report capital gains and losses from their exchanges of coins.

But that was five long years ago. It seems the IRS must have felt that taxpayers were due for a reminder about their possible tax liability for their cryptocurrency sales and trades. So this past July, it sent three different letters out to taxpayers reminding them that their cryptocurrency investments bring with them reporting requirements and perhaps a tax liability. The IRS expected to send these letters to more than 10,000 taxpayers during the summer of 2019.

The first letter was sent to taxpayers who “have or had one or more accounts containing virtual currency and may not have met [their] U.S. tax filing and reporting requirements for transactions involving virtual currency . . .  .”

The second letter was sent to taxpayers who “have or had one or more accounts containing virtual currency but may [have] not know[n] the requirements for reporting transactions involving virtual currency . . . .”

The third and final letter was sent to taxpayers who “have or had one or more accounts containing virtual currency but may not have properly reported [their] transactions involving virtual currency. . . .”

According to the IRS, the names of the taxpayers who received these letters “were obtained through various ongoing IRS compliance efforts.” These efforts might have included sending summonses to cryptocurrency exchanges seeking information about accountholders with accounts in excess of certain amounts. That is how the IRS obtained information in 2018 about 13,000 people who had cryptocurrency accounts with Coinbase™, which describes itself as a “digital currency wallet and platform where merchants and consumers can transact with new digital currencies.”

Knights in Shining Armor?

Cryptocurrency companies and investors who are not pleased with the taxation of cryptocurrency gains may wish to direct their support and political contributions to Congressman Warren Davidson (R-OH) and Congresswoman (and 2020 presidential candidate) Tulsi Gabbard (D-HI).

 

They are both co-sponsors of the Token Taxonomy Act, which was introduced in the House of Representatives in April 2019. The bill would amend the Securities Act of 1933 and the Securities and Exchange Act of 1934 to, among other things, “create a tax exemption for exchanges of one virtual currency for another” and a “de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash.”

 

As promising as this legislation is for advocates of cryptocurrency, the bill is a long way from becoming law. And unless and until Congress takes action, the IRS is unlikely to change its stance on cryptocurrency.