Warm-up: Cryptocurrency, IRS and Taxes
Cryptocurrencies can be used just like fiat currencies to buy goods and services. Hence, they are now listed on market exchanges and have been paired with the world’s major currencies such as the US dollar and the euro as well.
At the start, many were attracted to Bitcoin (the most popular cryptocurrency) due to the fact that it was not regulated by a central authority. Moreover, people used it to perform transactions as it avoided tax obligations. However, it was impossible for Bitcoin to slide through the tax authorities’ radar for long.
Keeping in the attention of people’s interest in Bitcoin, tax authorities around the world have tried to put forth regulations on digital currencies. The U.S. IRS said that Bitcoin must be treated as an asset and not a currency. This is because it is not issued by the central bank of a country. Also, treating Bitcoin as an asset makes the tax implications clear.
Recently, the Internal Revenue Service has made it mandatory to report transactions made through Bitcoin, irrespective of the value. So, every taxpayer in the U.S is required to keep a log on all the buying, selling and investing in Bitcoin. Goods and services bought by paying through Bitcoins must be recorded as well.
There are a set of transactions which are considered taxable and non-taxable.
The taxable transactions include:
- Exchanging cryptocurrency for fiat money (government regulated money)
- Paying for goods and services. For example, buying coffee using Bitcoin
- Exchange cryptocurrency for other cryptocurrencies
- Receiving mined or forked cryptocurrencies
If you make any of the above transactions, then you must disclose it to the IRS or face evasion charges.
The non-taxable transactions, according to the IRS, include:
- Purchasing cryptocurrency using fiat money
- Donating cryptocurrency to a tax-exempt firm or charity
- Gifting cryptocurrency to a third party (under $15,000)
- Transferring cryptocurrency between wallets
IRS and its Letters to Virtual Currency Investors
People who got benefited from their cryptocurrency investments, now have a new challenge to traverse in the coming days – the IRS and taxes. Many monetary authorities are finding it challenging to regulate cryptocurrencies. However, the tax authorities, on the other hand, are scrutinizing and trying to levy tax from investors who made good returns from trading, investing and dealing cryptocurrencies.
From the last week of July, the IRS has begun to send letters to more than 10,000 taxpayers who own virtual currencies. The letter basically instructs the taxpayers to review their returns and amend them accordingly.
The IRS Commissioner Chuck Rettig made a statement, “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties.” “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations,” he further added.
How has the IRS been obtaining investors’ addresses to send the letters?
Bitcoin, or any other cryptocurrency for that matter, technically allows its holders to be anonymous. That is, all the personal information of the investor remains private. Also, most people have bought Bitcoin through exchanges, where they have users’ identification information and documents.
For instance, the IRS had won a court to access holders’ information from Coinbase (a well reputed U.S exchange that verifies the identity of customers). However, the IRS did not drop even a clue, if this is how it got the addresses of investors to contact about taxes.
Did you receive the letter 6173, 6174 or 6174-A from the IRS? Here’s the action you need to take regarding it
The IRS has been sending the educational letter in three variations – Letter 6173, Letter 6174 or Letter 6174-A. But, the receivers are confused about what they should do once they’ve received the letter.
Well, what you should do entirely depends on the type of letter received.
Letter 6174 and Letter 6174-A does not require any action. This means that you don’t have to react to these letters if you have met all the crypto tax filing onuses mentioned in the letter. These letters basically recommend you to file your amended returns if you think you’ve not appropriately filed the crypto taxes in the past years.
Coming to the Letter 6174-A, it requires your action. If you fail to respond to this letter on time, then your tax account will be audited by the IRS. In this letter, you must read through the “What you need to do by the ‘respond by’ date above” section and produce the necessary documents to the IRS.
Note that, these letters are educational letters sent by the IRS. You may receive it even if you are fully obedient with all your crypto tax reporting. These mechanisms intend to increase crypto tax reporting compliance and not penalize to the taxpayers.
There are two more popular letters the IRS sends the taxpayers – Letter CP2000 and CP2501.
When a tax return’s information does not match data reported by the taxpayers to the IRS, then the IRS will send a letter to the taxpayer for the same. This letter is called an IRS notice CP2000, which contains detailed information on the issue and also provides the steps to solve the issue. This letter isn’t a formal audit notification but is a letter of agreement if the taxpayer agrees or disagrees with the proposed tax changes. Moreover, taxpayers must revert to the letter within 30 days from the date printed on the letter.
This notice from the IRS is a close cousin of the CP2000. This letter requests clarification between your tax return and information from other sources. However, it does not have a proposed balance due.
If you receive this letter, it is advised to order a transcript of your tax return, as this will display all the information the IRS has associated with your social security number. And, one can request a transcript of your tax return using the Form 4506 – T.
Forms one must produce to report cryptocurrency taxes
If you are a citizen of the United States, then you will need to file the following forms.
Form 8949 – Sales and Other Depositions of Capital Assets. Including this, you will have to submit a complete list of every cryptocurrency clearance you have had, including selling, trading, and sending to a third party.
Schedule D – Capital and Gain Losses.
Form 1040 – Individual Income Tax Return
Schedule C – Profit or Loss from Business
Schedule 1 – Additional Income and Adjustments to Income
Note: From the above forms, the mandatory forms required are – Form 8949 and Schedule D.
Implications if you do not file your cryptocurrency gains
For no-reporting or under-reporting of income from various sources, the IRS has the supremacy to accuse you to a failure-to-pay penalty. In this penalty, the IRS charges 0.5 percent of the unpaid tax amount per month. And, this begins from the month in which the tax was due for payment. It is best to consult a crypto tax guide to become familiar with cryptocurrency taxes if you intend to file.
The second type of penalty is for late filing. The IRS levies 5 percent of the unpaid taxes each month, starting from the month in which the tax was due.
Moreover, there may even be interest payment due to this late payment and filing.
Hence, to avoid some possible penalties and charges, the IRS advises holders, to “file even if you can’t pay”.
On 26 July, the Internal Revenue Service announced that it has started sending letters to American crypto owners ordering them to pay their taxes. According to the IRS, letters of three types will be sent to more than 10,000 taxpayers by the end of August.
Furthermore, the IRS press release specified that “Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties, and interest.” And, in certain scenarios, the taxpayers could be subject to criminal prosecution as well.
Hence, the cryptocurrency holders are advised to take these letters seriously and scrutinize the issues accordingly.