The world of cryptocurrencies is a challenge for many California taxpayers to understand. Many individuals may not even be familiar with the relevant Bitcoin terminology, let alone how to comply with its tax requirements. The IRS has recently increased its monitoring of Bitcoin use and enacted new guidelines for tax regulation and compliance. Described as the first decentralized digital currency, Bitcoin is becoming more and more widely accepted as a form of payment. There were reportedly 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. Since the use of Bitcoin is constantly increasing, taxpayers would be well-advised to learn the basics about digital income and how to properly report it on their tax returns.
Taxpayers that deal in Bitcoin or other digital currencies should assess potential liability, make appropriate disclosures and achieve compliance. This area of tax law poses many questions about cryptocurrency tax implications and reporting requirements. This new technology comes with many complexities that are best explained by a knowledgeable Sacramento tax attorney. NewPoint Law Group has the experience and skill to answer all of your tax and digital currency questions. 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 in Sacramento?
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. Without the use of any third-party administrator or central authority, Bitcoin allows each user the ability to freely and directly choose with whom they make transactions.
Bitcoin works on the basis of what is 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 within a short time after, by a process called mining.
Is Bitcoin Considered Taxable Income in Sacramento?
Anything that you receive as payment for goods or services is generally taxable income unless it is specifically exempted. Wages paid to employees using virtual currency are taxable to the employee and must be reported by an employer on a Form W-2. They are also subject to federal income tax withholding and payroll taxes. If you were tipped, as long as it was not for any provided product or service, then it is gift and not due taxes. If you were given the cost basis along with those tips, you can use this information to reduce any gains when you come to sell them. However, you are not permitted to declare losses from the basis of these coins. You must instead use the fair market value. 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.
How Does the IRS Tax Cryptocurrencies in Sacramento?
Bitcoins used to pay for goods and services are taxed as income. If you hold Bitcoin as a capital asset, then general tax principles applicable to property transactions apply. If the Bitcoin is held in the form of stocks or bonds, any gain or loss from the sale or exchange of the asset is taxed as a capital gain or loss. Otherwise, the investor realizes ordinary gain or loss on an exchange. The IRS reasoned this determination on the basis that unlike traditional currencies, Bitcoin is not regulated or governed by a central authority or national bank. Bitcoin does not have legal tender status in any nation or jurisdiction.
The IRS has provided guidance on how to treat Bitcoin. U.S. taxpayers who hold and transfer Bitcoin should record the value of Bitcoins when they are obtained. They should also record the value of Bitcoins when the digital currency is sold, traded, transferred, or otherwise disposed of. The difference is value is the capital gain or loss. 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.
How Are Mined Bitcoins Treated for Tax Purposes in Sacramento?
Bitcoins are the first digital currency that were created in a manner that allows for mining and still have a significant value in relation to other currencies. Since Bitcoins are currently traded in various online marketplaces, when someone receives a bitcoin, they can reasonably calculate its value in the local currency. Therefore, it is possible the IRS treats the receipt of a bitcoin through a mining pool, or from an individual mining operation, as a taxable event.
The IRS stipulates in its guidelines that after determining the fair market dollar value of the Bitcoin as of the day of receipt, the earner of the mining income must include the amount in their gross income. If a bitcoin miner is self-employed, his or her gross earnings minus allowable tax deductions are also subject to the self-employment tax. It is also possible that the government will consider mined bitcoins ‘intangible personal property.” Financial instruments are typically excluded from this particular category.
What Happens to Lost or Stolen Cryptocurrencies in Sacramento?
The proper way to label lost or stolen cryptocurrencies presents a big problem for taxpayers. It would be nice to think that these events are exempt from taxation guidelines, but unfortunately that’s not the case. In fact, they may even lead to unfavorable tax treatment in the long term. Whether the Bitcoin funds are lost due to user error or illegal activity by a third party, the user remains responsible for reporting the income.
The IRS will likely want proof if the amount deducted is large, though you can still write off the loss on your federal return. The options for writing off the loss may change depending on whether the Bitcoin was lost or stolen. For this reason, the IRS advises that Bitcoin users keep fastidious records of all cryptocurrency activities. Periodically downloading your trading history and exporting transaction logs from your Bitcoin wallets are also helpful when it comes time to report.
What Are the Penalties for Not Complying with Bitcoin Reporting Requirements in Sacramento?
Failing to comply with any tax regulations, including those involving digital currency, comes with serious potential penalties. 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, unless it is specifically exempt. 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). Improper use of Bitcoin can also result in employment taxes or self-employment tax problems.
Can I Appeal a Bitcoin Determination by the IRS in Sacramento?
If your tax issue has already been assessed by the IRS and you feel that the conclusion reached was unfair, you have the right to file an appeal in California. After the completion of the audit, you will receive a letter from the IRS informing you of your right to appeal, generally lasting for 30 days after the determination has been made. If you fail to respond to this letter, you will likely receive a Notice of Deficiency. If the amount in controversy is less than $25,000, you can elect to file for a small case review. Taxpayers who have passed this point in time should also keep in mind that the collections process is also subject to appeal.
Contact an Experienced Sacramento Bitcoin Attorney Today
Bitcoin users in Sacramento have many more questions about the tax implications of cryptocurrencies than the ones we have answered here. Those who are concerned that their Bitcoin activities have triggered a taxable event should contact an experienced tax attorney to ensure they are in compliance. The tax attorneys of NewPoint Law Group have extensive experience in all areas of tax law and can deliver on-point guidance and aggressive advocacy. Contact us today at 1-800-358-0305 today or contact our firm online to assess your circumstance and develop a virtual currency income tax compliance plan.