Digital assets are regarded as property for tax purposes in the United States. Consequently, the specific tax laws that apply to property transactions also apply to transactions involving virtual money. These transactions include the buying and selling of stock or real estate. Virtual currency transactions of various kinds may necessitate taxation and reporting.

Taxation of transactions

• Sales. Subject to any restrictions on the deductibility of capital losses, you must record any capital gain or loss on the sale of virtual currency. The difference between your adjusted tax basis in the currency and the amount you get for it constitutes the gain or loss. A report of the sum you receive must be in U.S. dollars on your federal income tax return.
• Your base is the fees, commissions, and other charges incurred to obtain the virtual currency. Your modified basis is your original, boosted by certain expenses and decreased by specific credits or deductions.
• Property exchanges. You must record a capital gain or loss if you exchange virtual money that you own as a capital asset for other property (such as goods or other digital assets). The gain or loss is the discrepancy between your adjusted tax basis in the virtual currency and the fair market value (FMV) of the item you acquire. Your tax basis in any other property you get in exchange for transferring a digital asset in an arm’s length transaction is equal to that asset’s FMV at the time of the exchange.
• Payment for services. Whether you perform the services as an employee or an independent contractor, you must recognize the FMV of the virtual currency as ordinary income when it is received. Your asset’s tax basis is also equal to its FMV.

On the other hand, suppose you pay for a service with virtual money that you own as a capital asset. In that case, you’ve traded a capital asset for the service. You will then experience a capital gain or loss. Additionally, federal income tax withholding, the Federal Insurance Contributions Act (FICA) tax, and the Federal Unemployment Tax Act (FUTA) tax apply to the FMV of the wages on the day of receipt that are virtual currency. There must also be a disclosure on Form W-2, “Wage and Tax Statement.”

Federal tax reporting obligations

You might have recently seen a new line on your federal income tax return. “At any time during 2022, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?” is the question posed in the 2022 edition.

If the answer is “yes,” you must declare all associated income. You must do so regardless of whether it is income, a capital gain or loss, or something else.

In late 2021, additional new reporting requirements for digital asset transactions came into play. These were brought on with the Infrastructure Investment and Jobs Act (IIJA). The purpose is to raise more money through taxes to support infrastructure initiatives. The regulations give the IRS additional data to work with. It also creates more potential compliance snares for taxpayers who transact in virtual currency.

The IIJA broadened the category of brokers who must file Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” That came from the IRS detailing the gains and losses incurred by clients when selling securities throughout the tax year. The sale description, cost basis, purchase date and price, selling date and price, and resulting short- or long-term gain or loss are typical requirements.

Reporting the taxation of virtual currency

Operators of digital asset trading platforms are subject to the same reporting requirements as conventional securities brokers under the IIJA. That would include cryptocurrency exchanges, for example. The IRS still needs to publish the final regulations with instructions, so it’s unclear when the restrictions will go into force. After implementing the new regulations, cryptocurrency platforms must request Form W-9, “Request for Taxpayer Identification Number and Certification,” from their users.

The IIJA also modified pre-existing regulations against money laundering to recognize digital assets as cash for their purposes. As a result, starting in 2023, companies that receive more than $10,000 in digital assets in a single transaction must file a report with the IRS. Companies that receive a series of related transactions must also file a report with the IRS.

This transaction must be on IRS Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business.” The business must collect the payer’s name, address, and taxpayer identification number, among other details, to complete the form. Violations could result in harsh civil and criminal penalties.

Please do not hesitate to contact our RRBB accountants and advisors with any questions. For more information, visit part one of this two-part blog series: https://rrbb.com/virtual-currency-lands-in-irs-crosshairs/.

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