As cryptocurrencies are becoming more mainstream, you may notice a lot more of your clients asking whether their virtual wallets affect their tax returns. Any taxpayer who has received, sold, exchanged, sent, or acquired any cryptocurrency during the tax year must now report those transactions on Schedule 1 and other appropriate schedules and forms.
How is virtual currency taxed?
Virtual currency is treated as property on a tax return. According to the IRS, “A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.”
If your client uses Bitcoin or another currency to purchase goods or services, you will need to report the transaction on their tax return. To do this, you will need to determine:
- Was there was a gain or a loss on the trade?
- Was it was short-term or long-term (short-term being less than a year)?
Report this information using Form 8949, then report is using Schedule D on Form 1040.
This also includes if your client trades one virtual currency for another virtual currency. Your client will not receive Form 1099 for these transactions. Instead, they will be responsible for keeping up with this information for tax reporting purposes.
If your client simply purchases virtual currency during the tax year, they will not be responsible for reporting it.
Specific situations for reporting virtual currency
Digital currency is becoming more prevalent as an increasing number of people and businesses use it to pay for services and items, make investments, and accept payments.
There is no stereotypical digital currency user, so you could see a diverse number of tax situations amongst your clients as cryptocurrencies catch on with:
- Independent contractors
- Wage-earning employees
- Shoppers who pay in virtual currency
While every client’s tax situation is unique, in general, the following rules apply.
If your client pays their employees in virtual currency
Virtual currency used to pay for goods and services should be taxed as income.
If your client is an employer who pays their employees with virtual currency, they will need to report employee earnings to the IRS on Form W-2.
They must convert the Bitcoin value to U.S. dollars on the date each payment is made and keep careful records. It is important to note that wages paid in virtual currency are subject to withholding to the same extent as dollar wages.
Self-employed clients with cryptocurrency gains or losses from sales transactions are also responsible for converting their virtual currency to dollars on the date each payment is made and reporting the figures on their tax return.
If your client holds virtual currency as a capital asset
Virtual currency held as a capital asset should be treated as property for tax purposes. The same principles that apply to property transactions apply to this type of asset. Any gain or loss will be taxed as a capital gain or loss.
The information in this article is up to date for tax year 2021 (taxes filed in 2022).