What You Need to Know about the Tax Implications of Virtual Currency
Collecting information from each taxpayer to complete their tax return has never been an easy task for tax and accounting practitioners. This is being exacerbated by the growing list of items that have tax implications that taxpayers don’t even know about. The first example that comes to mind for many professionals is Bitcoin. Were you aware of the several activities related to Bitcoin that require reporting for tax purposes?
Before we go any further, let’s first understand some key terminology. Virtual currency is a digital representation of value that was not issued by something like a central bank. There are virtual currencies based on cryptographic algorithms, also referred to as cryptocurrencies, of which Bitcoin is arguably the most recognizable. For now, we will simply use the term “virtual currency” when referring to Bitcoin and its alternatives.
For federal tax purposes, virtual currency is treated as property. This means that tax principles generally applicable to property transactions also apply to transactions in which virtual currency was used. Most are still asking the same question – when does virtual currency have tax implications? Let’s review some scenarios:
- Selling / Exchanging – The sale or exchange of virtual currency, including for goods or services in commercial transactions, must be included as a capital gain or loss.
- Mining – Virtual currency that was mined must be included in gross income.
- If this constitutes a trade or business and the mining activity is not undertaken by the taxpayer as an employee, then the net earnings resulting from those activities constitute self-employment income and are subject to the self-employment tax.
- Compensation – Virtual currency received as payment for goods or services must also be included in gross income.
- Payments – Wages paid or payments made to an independent contractor, employee, or other service provider using virtual currency must be considered.
One requirement common to everything on the list above is the need to determine the fair market value of the virtual currency as of the date of activity. Many virtual currency exchanges will provide ways for taxpayers to generate reports or export this information, but this will only result in having the data in an Excel file or spreadsheet. To streamline the process of reporting this information, tax compliance solutions must provide flexible, comprehensive import capabilities rather than requiring that preparers manually re-key all of this data.
Because these are relatively new topics, it’s important to proactively communicate the need for this information to all clients. Tax compliance solutions, like UltraTax CS and GoSystemTax RS offer organizers or data collection tools, to ask your clients questions about their use of virtual currencies. Data mining functionality within UltraTax CS could help you target these clients, and proactively communication next step information in a client newsletter.
Those firms proactively communicating the need for this information to their clients are providing a great deal of value in the form of saving time and avoiding penalties, while also conveying a progressive image since virtual currencies are often associated with cutting-edge technology and the latest financial trends. These are the types of firms for which millennials seem to be searching.
Learn more on how tax software for accountants can help turn your firm into a one-stop, full-service tax advisory resource for your clients.