As Bitcoin continues to rally to new heights, a growing community of investors and businesses are gravitating towards trading their dollars for Bitcoins, Ethers, and even Litecoin for consumer transactions and employee wages. With cryptocurrencies growing in popularity, there still remains a large elephant in the room: how are cryptocurrency transactions taxed? Although the federal and state governments are just starting to address these issues, the Internal Revenue Service (IRS) recently published some guidance on how business owners should report cryptocurrency income. Here are a few takeaways to keep in mind heading into tax season:
According to the IRS, cryptocurrencies are treated and taxed as property transactions. This means that, unlike traditional fiat currency purchases and investments, any gains or losses related to cryptocurrencies will be subject to capital gains taxes, capital loss deductions, and additional recordkeeping requirements. Therefore, if you’re a business owner who is considering accepting cryptocurrency payments from consumers, you’ll need to note and report the purchase and sale values for your coins and factor in appropriate capital gains taxes and deductions from the fair market value of cryptocurrency transaction made. This could create major accounting headaches for your business if you handles high volumes of cryptocurrency transactions—especially with daily cryptocurrency transactions now surpassing 370,000 . Businesses may also be required to supply their taxpayer identification number (TIN) to consumers and vendors so that they can adequately report their transactions since the IRS also considers all cryptocurrency-based transactions subject to backup withholding requirements.
More and more companies are cashing off of the cryptocurrency boom by conducting initial coin offerings (ICOs)—also known as “token sales”—as a way to raise funding for new token ventures. Unlike an initial public offering (IPO), where business owners usually give up equity in their companies in exchange for funding, companies running token sales will distribute discounted bulk amounts of a new cryptocurrency in exchange for units of a more established cryptocurrency—usually Ether or Bitcoin. Another critical distinction, however, is especially worth noting. While proceeds from equity funding are tax-exempt, ICO proceeds could be treated as taxable income. The taxable value of these proceeds is usually measured from the date the ICO ended or from the date you otherwise took control of the proceeds[PE1] , and could potentially be subject to state & local taxes in addition to federal taxes. This amount could even be taxed out of your own personal earnings if you did not formally organize your business prior to the ICO. This will likely force business owners to consider tax-exempt and off-shore options for conducting ICOs.
Just because a company decides to pay its employees using cryptocurrencies instead of dollars or Euros doesn’t mean it’s also immune to wage tax withholding requirements. According to the IRS, all payments paid to employees are subject to income withholding requirements regardless of what form of payment the business uses to pay the wage. Therefore, the fair market value of an employee’s cryptocurrency earnings must be included on that employee’s W-2 form, and these wages will also be subject to federal income tax withholding, Federal Unemployment Tax Act, and Federal Insurance Contributions Act requirements that apply to property-backed payments.
Business owners who are exploring using cryptocurrencies to pay independent contractors and carry out business-to-business (B2B) payments aren’t immune to information reporting requirements just because they’re using virtual currencies. So if a company pays rent, salaries, annuities or other compensation using cryptocurrency transactions that are valued at $600 or more—and the recipient is not considered a tax-free entity—the company is required to report the fair market value of each transaction at the time of payment both to the IRS and to the recipient. If you’re also making payments to independent contractors for services rendered, you would also need to be reported payments valued at over $600 on the contractor’s Form 1099-MISC. Failure to do could result in hefty fines for your business.