Cryptocurrency has evolved from a somewhat obscure technological term in the late 2000s to a budding, potentially lucrative financial investment in just under a decade. Bitcoin (BTC) is one of the oldest, emerging on the scene in 2009, but over time hundreds of other “altcoins” and “tokens” have manifested, including Ethereum (ETH), Litecoin (LTC), and Ripple (XRP), to name a few.
These digital assets have been made possible by blockchain technology, a decentralized digital ledger that allows users to trade cryptocurrency online without the oversight of a third party, such as a centralized bank. The decentralized and seemingly immaterial nature of cryptocurrency makes it harder for government agencies such as the IRS to track and enforce the taxation of them, beyond a standard tax audit. Nevertheless, countries around the world are taking note of the growth of cryptocurrency and the enormous tax revenue potential of what some are calling “the future of currency”.
What Is the Blockchain?
The blockchain was invented by a person or group who goes by the pseudonym “Satoshi Nakamoto”. Like the internet, it exists as a shared database that is constantly checking itself for continuity, allowing for digital information to be distributed or transferred without being copied. This is how cryptocurrency can exist digitally without anyone making copies, the way that you might “copy” a computer file.
The ability to verify the authenticity of digital files means that the blockchain can be used for more than just digital currency. Smart contracts between worldwide buyers and sellers mean that global contracts can be signed without notaries and verified in minutes, for example, drastically reducing cost of as well as time to execute international trade. The versatility of the blockchain as a new innovative technology has piqued the interest of investment firms across the country. However, four investment firms in particular are eyeing the blockchain and cryptocurrency in general.
The Big Four Investment Firms and Cryptocurrency Exchanges
The four largest accounting firms in the world, Deloitte, Ernst & Young (EY), PricewaterhouseCoopers (PwC), and KPMG, have all begun engaging with bitcoin and blockchain technology in one way or another. Deloitte recently announced a partnership to provide clients with initial coin offering (ICO) services and solutions, while EY became the first of the advisory firms to accept BTC for its services in select locations. PwC has begun efforts to enable digital assets be used in everyday banking and commerce, and KPMG has also thrown in on blockchain initiatives.
With the Big Four throwing their weight behind the blockchain and cryptocurrencies like BTC, it’s not surprising that public interest in the subject has begun to blossom too. As such, the number of people “mining” BTC and other cryptos has increased, while the number of people exchanging cryptocurrencies for fiat or other forms of cryptocurrency has skyrocketed. Investment and speculation have driven the price of one BTC from less than one cent in 2009, to $13 USD at the end of 2012, to over $5,000 in September 2017. The explosive valuation of these assets has caught the attention of governments and national agencies around the globe, including the IRS.
The IRS and Bitcoin Tax Regulations
Because it can be used as a virtual currency or held as a digital asset, the tax implications associated with cryptocurrency are not always clear. Nonetheless, trading cryptocurrency is a taxable event. Indeed, cryptocurrency holders are either unaware entirely that these tax implications exist, or are intentionally declining to adhere to them; only 802 people reported earnings related to digital assets to the IRS in 2016 — despite the fact that Coinbase, one of the most popular cryptocurrency trading platforms, hosted over one million user accounts in that year. This glaring difference prompted the IRS to serve Coinbase a John Doe summons in order to obtain the identities of all Coinbase users active from 2013 to 2015. It is believed that Coinbase is simply the first of many IRS tax audit targets.
To make sure that taxpayers are in the clear with the IRS on BTC and other cryptocurrency regulations, the IRS recently released Notice 2014-21, which offers guidance on virtual currency taxation. The “frequently asked questions” section breaks down and clarifies surrounding virtual currency and digital assets. For example, elucidating that cryptocurrency are treated as property, and that “general tax principles applicable to property transactions apply to transactions using virtual currency.”
As such, when holding BTC or other cryptocurrency as a capital asset, any gains or losses from the sale or exchange of the asset should be treated as a capital gains or losses. When BTC is used to pay for goods and services instead of held as capital assets, such as when an employer uses cryptocurrency to pay employees, those earnings must be reported to the IRS on W-2 forms. Intuit points out that:
- You must convert the Bitcoin value to U.S. dollars as of the date each payment is made and keep careful records.
- Wages paid in virtual currency are subject to withholding to the same extent as dollar wages.
Self-employed individuals are held to the same standard, and must also convert virtual currency to dollars as of the day they’re earned, and report those figures on their tax returns. Those who fail to report cryptocurrency earnings are subject to tax evasion penalties.
A Disruptive New Wave of Digital Currency
The blockchain itself represents a revolutionary, new technology with untapped potential and the power to disrupt financial institutions as we know them. This has prompted aggressive regulation and tax audits by the IRS, and requires new and progressive approaches by business tax professionals who wish to understand and utilize cryptocurrencies properly.
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