The IRS Wants to Know About Your Cryptocurrency Transactions – Interesting Engineering

Cryptocurrencies, such as Bitcoin, Litecoin, Ethereum, and Ripple, make the U.S. Internal Revenue Service (IRS) nervous. They want to know what you're up to so that they can tax it, and due to COVID-19, you must file your 2019 income tax by July 15, 2020.

On their new Schedule 1 form, the IRS has thrown in a new question: "At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?"

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Unless you have a death wish, or don't mind doing hard time, you've got to include your cryptocurrency dealings on your income tax filing. We're going to tell you how to do it, but first, a disclaimer.

We're not tax professionals, so take the facts provided below as informational only. Also, those living in countries other than the U.S. may have very different income reporting obligations.

The IRS identifies cryptocurrencies as property, just like collectible coins, valuable paintings, vintage cars, or stocks. Property can appreciate or depreciate in value.

You must report all cryptocurrency transactions and all cryptocurrency, or digital currency income even if you didn't receive a tax form from a cryptocurrency exchange.

While some exchanges, such as the popular site Coinbase, provide a transaction history to every customer, they only provide an IRS Form 1099-K to those customers whose transactions meet a certain dollar amount.

According to the IRS website, "A Form 1099-K includes the gross amount of all reportable payment transactions, and you will receive a Form 1099-K from each payment settlement entity from which you received payments in settlement of reportable payment transactions."

The IRS requires you to report your gains and losses on each of your cryptocurrency transactions. You report cryptocurrency transactions at their fair market value in U.S. dollars.

To calculate your gains and losses, you'll need the cost basis of each transaction, that is, the amount you spent in dollars to buy the cryptocurrency and the amount in dollars that it was worth when you sold it. You can use losses to offset capital gains, thus making losses deductible.

You must pay taxes on cryptocurrency if you:

You don't have to pay taxes on cryptocurrency if you:

Section 501(c)(3) is the portion of the U.S. Internal Revenue Code that allows for federal tax exemption of nonprofit organizations, specifically those that are considered public charities, private foundations or private operating foundations.

On its website, the IRS states that "Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes."

An airdrop is a usually free distribution of a cryptocurrency token or coin to numerous wallet addresses. Airdrops are done to help newer cryptocurrencies gain attention and new followers.

Recipients are either selected randomly or the airdrop is publicized on bulletin boards or in newsletters. Some airdrops require joining a group, retweeting a tweet, or inviting new users.

Airdropped cryptocurrency should generally be taxable as ordinary income, and valued at its fair market value on the date of receipt. If your exchange doesn't yet support the new coin, meaning it can't be sold, then it isn't taxable.

A fork is an upgrade to a blockchain network. Permanent forks are used to add new features to a blockchain, to reverse the effect of hacking, or to fix bugs, as was the case with the Bitcoin fork that occurred on August 6, 2010, or the fork that separated Ethereum and Ethereum Classic.

Crypto that is received in a fork becomes taxable when it can be transferred, sold, or exchanged. The IRS discusses forks on its Frequently Asked Questions on Virtual Currency Transactions webpage.

Things get even more complicated if you bought cryptocurrency at different times, then sold only a portion of it. You need to choose the cost based on FIFO (First-in-First Out), LIFO (Last-in-Last Out), or the Specific Identification method, which identifies exactly which coins were sold. This IRS page provides information on this choice.

If there is one thing the IRS has a lot of, it's forms. Some of those you may need to use to report cryptocurrency on your income tax include:

If you followed the last link provided, you land on an IRS page with the word "Attention" in red, which is never a good sign. It's followed by several paragraphs, the first of which states: "Copy A of this form is provided for informational purposes only. Copy A appears in red, similar to the official IRS form. The official printed version of Copy A of this IRS form is scannable, but the online version of it, printed from this website, is not. Do not print and file copy A downloaded from this website; a penalty may be imposed for filing with the IRS information return forms that cant be scanned. See part O in the current General Instructions for Certain Information Returns, available at http://www.irs.gov/form1099, for more information about penalties."

If you understood this last paragraph, please let me know so I can put you up for a MacArthur Genius Grant. In the meantime, in July 2019, the IRS sent out over 10,000 letters telling recipients that they owed back taxes, interest, and penalties on their cryptocurrency transactions and that they needed to file amended returns. The IRS also lets recipients of the letters know that they could possibly face criminal prosecution and fines of up to $250,000.

In case you think dabbling in cryptocurrency sounds too complicated, consider this: on March 20, 2020, the value of Bitcoin rose 23% in just 24 hours, reaching $6,172.61.

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The IRS Wants to Know About Your Cryptocurrency Transactions - Interesting Engineering