Cryptocurrency is…complicated. You’ve definitely heard about it, and probably know someone who has either lost big or became an overnight millionaire because of it. Buzz words and terms get thrown around constantly like “blockchain” and “mining”, but what exactly is cryptocurrency? And why is IRS’ treatment of the new currency shrouded in so much mystery?
As a decentralized, virtual form of currency that only exists in the digital world, cryptocurrency is truly unique. There is no dealing with tangible crypto-dollars or crypto-cents, as well as no regulation or oversight by any national government or central bank.
Cryptocurrency exists in an exclusively virtual state and relies on a technology known as blockchain to keep it secure and transferrable. Cryptocurrencies are created through a “mining” process, whereby miners use powerful computers to authenticate transactions in a digital ledger of transactions. People can trade cryptocurrency on digital trading platforms, hold it for investment in digital “wallets,” use it to pay for goods and services, or loan it to others.
Because of the unique nature of crypto, the Internal Revenue Service has had trouble nailing down how to treat the new digital “currency”.
Since Notice 2014-21, the tax treatment of cryptocurrency has been addressed in a general form. Essentially, the IRS alerted taxpayers that cryptocurrency will receive the same treatment as other property. The problem however is that due to the way that the “currency” exchanges owners, complications on how to enforce have already occurred.
Because cryptocurrency is property and not cash, owners must track the difference in value between acquisition and disposition, which has led to extremely low reporting rates and to complicated tax ramifications. For instance, a taxpayer that spoke with the alliantNational team received a 1099 form from Coinbase reporting $5MM in gain, when in reality, due to the complicated tracking matters pertaining to basis and timing, the taxpayer only had $250k in reportable gain.
On top of that, there are other questions on the treatment of the individuals who also perform the mining of cryptocurrency. The IRS treats cryptocurrency mining income the same as business income, and miners must report their activity to the IRS if they’ve received more than over $400 through their mining efforts. However, with the aforementioned treatment of the “currency” as property by the IRS, does this mean the miner is manufacturing property? Questions like these have yet to be fully address by the Service.
With so many questions around cryptocurrency and the thousands of people holding or trading in cryptocurrency, the alliantNational team is here to answer your complex tax questions. Please contact Steven Miller, National Director of Tax.