Though it has been over eight years since its development, many American taxpayers are still unfamiliar with Bitcoin and its place in our tax system. Hailed as the first decentralized digital currency, Bitcoin is becoming more and more widely accepted as a form of payment. According to research produced by Cambridge University, there were between 2.9 million and 5.8 million unique users using a cryptocurrency wallet in 2017 and hundreds of thousands of merchants accepting it as payment. The Economist describes the digital asset as, “hard to earn, limited in supply and easy to verify.”
Bitcoin and other digital currencies pose many questions about tax implications and reporting requirements. This new technology comes with many complexities that are best explained by a knowledgeable California tax attorney. NewPoint Law Group has the experience and skill to handle all your tax and estate planning needs. To discuss whether your activities with Bitcoin have created taxable events or tax reporting obligations, call 1-800-358-0305 today or contact our firm online.
What Is Bitcoin and How Does It Work?
If you’re not yet familiar, Bitcoin is a worldwide cryptocurrency and digital payment system invented by an unknown programmer in 2009. The peer-to-peer system uses encryption techniques to regulate the generation of units of currency and verify the transfer of funds. Bitcoin transactions operate independently of a central bank, without the use of an intermediary. Having removed any third-party administrator or central authority, Bitcoin allows each user the ability to freely and directly choose with whom they make transactions.
All confirmed transactions are included in what’s known as the block chain—a shared public ledger on which the entire Bitcoin network relies. This allows Bitcoin wallets to calculate their spendable balance and verify that the bitcoins used in new transactions are actually owned by the spender. Unlike traditional forms of hard currency which are backed by gold or other precious metals, artificial scarcity has been designed into the Bitcoin model. A transaction is actually the transfer of value between Bitcoin wallets that gets included in the block chain. A secret piece of data called a private key or seed is used to sign transactions, providing a mathematical proof that they have come from the owner of the Bitcoin wallet. These transactions are then broadcast between users and confirmed by the network shortly after, by a process called mining.
What Are the Reporting Requirements and Tax Implications for Bitcoin in California?
There have been roughly 21 million Bitcoins created, but not all of them have been discovered yet. Users have the option to mine for Bitcoins by contributing computing power to maintain the public ledger (block chain) containing all of the Bitcoin transactions. Therefore, users are being compensated in the form of Bitcoins for the work they perform to keep the Bitcoin network running. Individuals who have successfully mined Bitcoins have realized income and a taxable gain. Self-employment taxes might also apply.
Individuals and merchants who accept Bitcoin as payment must also generally pay taxes on the income. The IRS has increased its monitoring of Bitcoin activities and stipulated that any individual holding or using Bitcoin is required to keep careful and precise records of their transaction. Failure to do so can leave a taxpayer vulnerable to tax penalties.
The IRS has provided guidance on how to treat Bitcoin. Though they do not technically meet the definition of a stock share, the normal basis rules apply to Bitcoins. Users, therefore, have the option to sell their assets on a first-in-first-out basis, a last-in-first-out basis, or a selective cost-basis method. Finally, a person who in the course of a trade or business makes a payment using virtual currency with a value of $600 or more may be required to report using Form 1099-MISC.
What Are the Penalties for Not Complying with Bitcoin Reporting Requirements?
Since many Bitcoin users are not aware of their responsibility to report gains and losses as taxable income each time they make purchases using Bitcoin, they are at risk for tax evasion. Taxpayers are required to report anything that could be considered income, from whatever source derived, to the IRS. Any person who willfully attempts to evade or defeat any tax liability can face a charge of tax evasion. If convicted, a taxpayer is guilty of a felony and is subject to other penalties allowed by law, in addition to imprisonment of up to 5 years, a fine of up to $250,000 for individuals or $500,000 for corporations, or both penalties, plus the cost of prosecution (26 USC 7201).
Work With an Experienced California Tax Attorney Today
The ever-expanding world of Bitcoin currency has much complexity beneath its surface. Cryptocurrencies and digital payment systems like Bitcoin present many complicated issues when it comes to reporting requirements and tax implications. Taxpayers need to be aware of their responsibilities when using Bitcoin in order to avoid under-reporting their income and subjecting themselves to a charge of tax evasion. If you are concerned about a failure to report Bitcoin income or unpaid capital gains taxes, the tax levy lawyers of NewPoint Law Group may be able to help. To schedule a confidential tax consultation at our Folsom or Roseville, California law offices, call 1-800-358-0305 today or contact us online.